Ethica CIFE Study Notes

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CIFE™ STUDY NOTES

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www.EthicaInstitute.com
ABOUT ETHICA
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ABOUT ETHICA INSTITUTE OF ISLAMIC

FINANCE
Winner of "Best Islamic Finance Qualification" at the Global Islamic Finance Awards, Ethica is
trusted by more professionals for Islamic finance certification. Training and certifying professionals in
over 100 financial institutions in 56 countries, Ethica's 4-month Certified Islamic Finance
Executive™ (CIFE™) is a globally recognized certificate accredited by scholars to fully comply with
AAOIFI, the world's leading Islamic finance standard. Ethica's award-winning CIFE™ is delivered
100% online or live at the bank. The Dubai-based institute is now supported by Licensed Ethica
Resellers in 11 countries.
Globally Recognized Certification

More people trust Ethica for Islamic finance certification. Period.
Ethica is the most trusted name in Islamic finance certification, successfully rolling out bank-wide
Islamic finance e-learning. We have done so across large banks (e.g. Mashreqbank's bank-wide e-
learning and certification), large academics (e.g. La Trobe University's accredited semester course in
Australia), and global corporates.
Ethica's Graduates Get Hired & Promoted

How does Ethica's CIFE™ give you the edge?
Ethica's Career Advancement Package includes personalized referrals to 3 financial institutions,

recommendation letters, 1-on-1 career counseling, job interview coaching, and a CV review.
The Fastest Way to Learn Islamic Finance Guaranteed

How is Ethica's CIFE™ program the 'fastest way to learn Islamic finance guaranteed'?
Just as 20% of your clothes get worn 80% of the time and 20% of your effort yields 80% of the
results, the 80-20 principle teaches us that there is an essential core at the heart of everything. We
give you the 80-20 of the Islamic finance world. When you sign up for Ethica's CIFE™ you get only
the most essential, practical Islamic finance knowledge distilled into an accelerated 4-month
program. And it's guaranteed because if you aren't super happy with Ethica's CIFE™ at any time,
you get all your money back. It's as simple as that. Dynamic and up-to-date material 24 hours a day,
rather than waiting around for outdated guidebooks, CDs, and distance learning emails. Our training
and certification is designed for maximum knowledge transfer without burdening you with more
information than you require. All the information, including spreadsheets, case studies, questions,
exercises, and quizzes is contained in the training videos.
About Ethica Institute of Islamic Finance 3

AAOIFI-Compliant, Industry-Accredited
Ethica's 4-month CIFE™ is certified AAOIFI-compliant by leading Islamic finance scholars &
approved by accredited Islamic institutions.
AAOIFI is the Accounting and Auditing Organization for Islamic Financial Institutions, the world's
leading Islamic finance standard for more than 90% of the industry. Remember, if it isn't AAOIFI-
compliant, it probably isn't Shariah-compliant.
100% Risk-Free, Money-Back Guarantee

Start your risk-free trial today! Cancel anytime.
If you aren't super happy with Ethica's CIFE™ at any time during the 4 month program, you get all
your money back. It's as simple as that! As a bonus, you also get 1-on-1 job coaching completely
free.
About Ethica Institute of Islamic Finance 4

ABOUT ETHICA’S
CIFE™
5
ABOUT ETHICA’S CERTIFIED ISLAMIC

FINANCE EXECUTIVE™ PROGRAM
Ethica's award winning CIFE™ is a
streamlined training and certification
program designed to take complete
newcomers to an advanced level of
understanding in Islamic finance in just 4
months.
The program fee is $1,495 (discounted for

selected developing countries), which can
be paid online or through wire transfer and
includes:
• 4 months access to self study videos
• 1 examination attempt
• CIFE™ Certificate couriered to your

home or office
• Ethica's 1-on-1 Career Counseling
• Ethica's Recruiter's Database
Ethica's 100% online delivery platform enables us to give you dynamic and up-to-date material 24
hours a day, rather than waiting around for outdated guidebooks, CDs, and distance learning emails.
Our training and certification is designed for maximum knowledge transfer without burdening you
with more information than you require. All the information, including spreadsheets, case studies,
questions, exercises, and quizzes is contained in the training modules.
Our experts are here to answer your questions over email (questions@ethicainstitute.com).
You get access to our entire inventory of training videos during your study-period. You can play each
video as many times as you like - 24 hours a day.
One module consists of an approximately 20 minute training video comprising a variety of

exercises, case studies, and quizzes, along which the student is expected to conduct his or her own
self-study. Experience with hundreds of other learners shows that the CIFE™ program is comfortably
manageable in about 1 to 3 months of training and about 1 month or less of studying for the
examination, enabling most users to complete the program in less than the 4 month access period.
There are no prerequisites for the Ethica CIFE™ though some prior knowledge of finance does help.
If you have no prior knowledge of Islamic finance, you've come to the right place. We designed the
About the Certified Islamic Finance Executive™ (CIFE™) 6

material specifically for newcomers seeking a high level of proficiency in the practical aspects of
Islamic finance in a very short amount of time.
There are no fixed dates for the program either. You can start whenever you like.
The CIFE™ Examination: A 90 minute timed exam comprising 100 multiple choice questions. The
pass mark is 70%.
How to take the exam: Login, click on 'My Account' and then click on 'Take CIFE™ Exam.'
Re-attempt: If you fail you can re-attempt the exam by paying a small fee.
Once you understand the 22 core modules listed below that comprise the testable material, you are
ready to take the 90-minute online CIFE™ examination. You can take the exam as soon as you are
ready. For some that's 3 months, for others it's more: you choose your pace. The recommended
study schedule shows you how to comfortably finish the program in the allotted 4-month period
with an investment of as little as 1 hour per week.
Course Recommended
Course Name Course Description
Code Study Schedule
CIFE01 Why Islamic Finance? What makes Islamic finance different from Week 1
conventional finance? And what makes it better? We
look at 3 real-world examples and find out. We also
introduce you to the 4 principles that guide Islamic
finance transactions.
CIFE02 Understanding You've heard of joint-stock companies. Now learn Week 1

Musharakah I (Islamic about the Islamic variation. We look at Musharakah,
Business Partnerships) the Islamic business partnership where partners pool
together capital, expertise or goodwill to conduct
business or trade. We look at the basic features of a
Musharakah and its types, their mode of operation,
duration and the various forms of capital contribution.
CIFE03 Understanding We discuss the management of the Musharakah Week 2

Musharakah II (Islamic business and take you through some practical
Business Partnerships) applications of how Islamic banks use Musharakah.
We also look at profit and loss sharing ahead of the
subsequent module's profit calculation exercises.
CIFE04 Understanding We complete our discussion on general aspects of Week 2

Musharakah III (Islamic Musharakah, including how banks handle negligence,
Business Partnerships) termination, and constructive liquidation. We round
and Quiz our discussion with some practical examples of
Musharakah calculation, a quick review of financial
statements and how exactly profit gets calculated.

Course Recommended
Code Study Schedule
CIFE05 Understanding Mudarabah I Where Islamic banks meet conventional private Week 3
(Islamic Investment equity type investing. Here you learn Mudarabahs,
Partnerships) the Islamic business partnership where one
partner supplies capital for the business and the
other provides management expertise. We explain
the Mudarabah structure and contrast it with
Musharakah and Wakalah, explaining how they
differ in banking practice.
CIFE06 Understanding Mudarabah How is an investment partnership different from an Week 3

II (Islamic Investment agency contract? We discuss the relative merits of
Partnerships) the Mudarabah and the Wakalah structure in
different situations. We also describe the
Mudarib's role, the duration of Mudarabahs and
the forms of capital contribution by the investor
and in some cases even the Mudarib.
CIFE07 Understanding Mudarabah We discuss the Mudarabah's management and Week 4

III (Islamic Investment the rules for sharing profit and loss. We also look
Partnerships) and Quiz at some practical examples showing how Islamic
banks use Mudarabahs.
CIFE08 Understanding Ijarah I What's an Islamic lease? This modules helps you Week 5
(Islamic Leasing) find out. We introduce Ijarah, the Islamic lease,
and look at prerequisites for their execution,
legal title, possession, maintenance, earnest
money, default, and insurance. We begin
answering the question "How does an Ijarah
work?" with step-by-step practical explanations.
CIFE09 Understanding Ijarah II You learn the rights and obligations of the lessor Week 5
(Islamic Leasing) and Quiz and the lessee and focus on defective assets,
sub-leases, extensions and renewals, transfer of
ownership, and termination.
CIFE10 Understanding Murabaha I Learn about the most widely used Islamic finance Week 6
(Cost Plus Financing) product: buy an asset for the customer; sell the
asset at a premium in installments to the
customer. That's a Murabaha. In these modules
we introduce Murabahas and walk you through
the first 5 of the 7 important steps necessary for a
Murabaha's valid execution.
CIFE11 Understanding Murabaha II Wrap up the 7 steps to executing a Murabaha: we Week 6

(Cost Plus Financing) cover steps 6 and 7 and go on to discuss common
mistakes bankers make when executing
Murabahas and how to avoid them. We also look
at risk management, default, early repayment, and
profit calculation in Murabahas.
CIFE12 Understanding Murabaha III So how does it work in the real world? We look at Week 7
(Cost Plus Financing) and 6 practical examples of Murabahas based on
Quiz installment repayments, bullet repayments,
advance payments, and credit and import
Murabaha.

Course Recommended
Code Study Schedule
CIFE13 Understanding Salam And What makes a forward contract Islamic? Learn Week 7
Istisna I (Forward Sales here. In this module on Salam, the Islamic forward
And Manufacturing sale, and Istisna, the Islamic manufacturing
Contracts) contract, we begin with Salam. We look at the
goods for which a Salam may be executed, the
prerequisites, and the use of a Parallel Salam.
CIFE14 Understanding Salam And We discuss security, replacement, and default Week 8
Istisna II (Forward Sales before explaining how its pricing is calculated. We
And Manufacturing then look at Istisna and discuss the major
Contracts) differences between it and the Salam.
CIFE15 Understanding Salam And In this final module we discuss delivery, default, Week 8
Istisna III (Forward Sales and termination an Istisna. We conclude the 3
And Manufacturing module series with a practical product structuring
Contracts) and Quiz exercise where you get to choose the appropriate
financing tools in a given scenario.
CIFE16 Understanding Islamic You learn the difference between Islamic and Week 9
Insurance and Quiz conventional insurance and the essentials that
make Islamic insurance unique. You walk through
a numerical example before taking the Self-
Assessment Quiz.
CIFE17 Understanding Sukuk I You've read about them. Now learn about them. Week 10
(Islamic Securitization) Sukuks are Islamic shares and we show you the
main features walking you through the 8 step
structuring process concluding with a study of
Ijarah Sukuk.
CIFE18 Understanding Sukuk II We continue our discussion on Sukuk with a look Week 10
(Islamic Securitization) and at Musharakah and Mudarabah, Sukuk and the
Quiz limitations of issuing using Murabaha, Salam and
Istisna. We close with a case study of the IDB
Sukuk.
CIFE19 Liquidity Management In What do Islamic banks do with excess capital in Week 11
Islamic Finance I the short- term? How do they access capital for
the long-term? You learn the answers to these and
other questions in this module. We discuss how
Islamic banks manage liquidity and begin by
explaining an inter-bank Mudarabah, walking you
through how a weightage table works; useful
information for other Islamic banking products. We
close the module with a look at the application of
Sukuk in liquidity management.

Course Recommended
Code Study Schedule
CIFE20 Liquidity Management In You look at filters for stocks, shares, Musharakah Week 11
Islamic Finance II and Quiz investment pools, and the use of agency contracts to
manage liquidity. We also look at local and the foreign
currency Commodity Murabahas and walk you
through the steps for executing each quiz.
CIFE21 Risk Management In Islamic Some have said "Banking is risk management." If you Week 12
Finance I don't know anything about risk management this is
the module for you. You learn the basics about risk
management in Islamic finance and discuss the most
common risks facing Islamic banks and the mitigation
techniques used to address them.
CIFE22 Risk Management In Islamic Now you learn about how risk relates to each specific Week 12
Finance II and Quiz Islamic finance product. We go through each major
Islamic banking product, namely Murabaha, Salam,
Istisna, Ijarah, Musharakah and Mudarabah, and
explain the specific risks associated with each quiz.
Week 13 - 16
• Review all modules
• Reattempt all self-assessment quizzes
• Examination

CIFE™ STUDY NOTES

A User’s Guide to Ethica’s
Certified Islamic Finance Executive™ Program
Important Note:
The following CIFE™ Study Notes are an accompaniment to the online training
modules available at Ethica and are not meant to replace the blended learning
experience of the complete Certified Islamic Finance Executive™ program.
CIFE™ Study Notes 11

CIFE01:
WHY ISLAMIC FINANCE?
What makes Islamic finance different
from conventional finance? And what
makes it better? We look at 3 real-
world examples and find out. We also
introduce you to the 4 principles that
guide Islamic finance transactions.
The difference between Islamic finance and
conventional finance is the difference between
buying and selling something real and borrowing
and lending something fleeting.
Conventional banking transactions are interest

based.
Islamic bank transactions are asset or service backed.
An asset or service cannot be compounded like an interest based loan. An asset or service can only
have one buyer or seller at any given time, whereas interest allows cash to circulate and grow into
enormous sums.
Interest creates an artificial money supply that isn’t backed by real assets resulting in increased
inflation, heightened volatility, rich getting richer, and poor getting poorer.
Nigerian President Obasanjo – Example
Nigeria took a $5 billion loan in 1985 and paid it off as $44 billion in 2000 as a result of compound
interest.
How would the Islamic bank manage such a developing country’s need?
• An Islamic bank could have arranged for the $4 billion construction of a natural gas pipeline
and delivered it to Nigeria for $5 billion using an Istisna.
• Or taken an equity stake in a highway project and shared in profits and losses using
Musharakah or Mudarabah.
• Or purchased commodities and sold them at a premium using a Murabaha.
• Or structured a project financing using an Ijarah Sukuk.

Nick the Homebuyer – Example
In 2009 Nick lost his job, his house, and all the money he had spent paying off his mortgage.
The property bubble that triggered the global financial meltdown could not have happened if the
properties had been financed Islamically because a conventional bank merely lends out cash.
Legally, it can keep lending this cash over and over, well above its actual cash reserves.
An Islamic bank, on the other hand, has to take direct ownership of an actual asset. Whether for a
longer period in a lease or partnership, or a shorter period in a sale or trade, Islamic finance always
limits the institution to an actual asset.
How could Islamic finance have fulfilled Nick’s need for a home?
Based on a Diminishing Musharakah.
Musharakah refers to partnership. In a Diminishing Musharakah, the bank’s equity keeps decreasing
throughout the tenure of the financing, while the client’s ownership keeps increasing through a
series of equity purchases. Eventually, the client becomes the sole owner.
At no time does the homebuyer pay any interest and at no time does any payment compound. The
homebuyer just pays for two things: the house, in small payments, little by little. And the rent, for the
portion of the house he doesn’t yet own.
Faisal the Student – Example
Faisal took a student loan. His university cost him $120,000 for four years. He began borrowing
$30,000 at the beginning of each year. Three years after graduation he began paying off his student
loans at the rate of $20,000 a year.
It took him 25 years to pay off his loan and he ended up paying over $400,000.
How would an Islamic bank fulfill Faisal’s need?
An Islamic bank could structure a service-based Ijarah to lease out the university’s credit hours.
Faisal ends up paying about 20% or 30% more; but with the interest-based loan, he pays about
400% more.
Islamic finance never can, and never will be able to grow Faisal’s debt once it’s fixed.
Islamic Finance Essentials
All banking products can largely be divided into the following 4 categories:
1. Equity
2. Trading
3. Leasing
4. Debt

Some important Islamic finance transactions:
• Equity based - Mudarabah, Musharakah, and Sukuk
• Trade based - Murabaha, Salam, and Istisna
• Lease based - Ijarahs
Islamic banking transactions must:
1. Be interest free.
2. Have risk sharing and asset and service backing: Based on the Islamic concept of “no return
without risk.” An Islamic bank takes a direct equity position, or buys a particular asset and
charges a premium through a trade or a lease. It uses risk mitigants, but not without first taking
ownership risk.
3. Have contractual certainty: Contracts play a central role in Islam and the uncertainty of
whether a contractual condition will be fulfilled or not is unacceptable in the Shariah.
4. Be ethical: There is no buying, selling, or trading in anything that is, in and of itself,
impermissible according to the Shariah for instance dealing in conventional banking and
insurance, alcohol, and tobacco.

CIFE02, 03, 04:

UNDERSTANDING MUSHARAKAH –
ISLAMIC BUSINESS PARTNERSHIPS
Yo u h a v e h e a rd o f j o i n t - s t o c k
companies. Now learn about the
Islamic variation. We look at
Musharakah, the Islamic business
partnership where partners pool
together capital, expertise or goodwill
to conduct business or trade. We look
at the basic features of a Musharakah
and its types, their mode of operation,
duration and the various forms of
capital contribution. We discuss the
management of the Musharakah
business and take you through some practical applications of how
Islamic banks use Musharakah. We also look at profit and loss sharing
ahead of the subsequent module's profit calculation exercises. We
complete our discussion on general aspects of Musharakah, including
how banks handle negligence, termination, and constructive liquidation.
We round our discussion with some practical examples of Musharakah
calculation, a quick review of financial statements and how exactly profit
gets calculated.
A Musharakah is a partnership that is set up between two or more parties usually to conduct
business or trade. It is created by investing capital or pooling together expertise or goodwill.
Partners share profit based on ownership ratios and to the extent of their participation in the business
and share loss in proportion to the capital they invest.
Profit cannot not be fixed in absolute terms such as a number or percentage of invested capital or
revenue.

Types of Musharakah:
• Shirkah tul Aqd
• Shirkah tul Milk
Shirkah tul Aqd is a partnership to enter into a joint business venture and trade. Partners enter into a
contract to engage in a defined profit seeking business activity.
Shirkah tul Milk is a partnership in the ownership of property or assets for personal use.
Every Shirkah tul Aqd has a Shirkah tul Milk imbedded in it, namely joint ownership of assets and
property.
Differences between Shirkah tul Aqd and Shirkah tul Milk
1. Shirkah tul Aqd is a direct contract of partnership in a business or income generating activity
whereas Shirkah tul Milk comes indirectly through contracts or arrangements unrelated to
production or income generation.
2. Shirkah tul Milk is a partnership of joint ownership as opposed to a commercial venture

(Shirkah tul Aqd). It may serve as source of income for one party but not for both.
3. In a Shirkah tul Milk ownership proportions cannot be specified however a Shirkah tul Aqd
cannot be formed unless the respective capital contribution shares of the parties are specified.
Types of Shirkah tul Aqd:
• Shirkah tul Wujooh: Partnership where subject matter is bought on credit from the market
based on a relationship of goodwill with the supplier.
• Shirkah tul Aa’mal: Partnership in the business of providing services. There is no capital
investment, instead partners enter into a joint venture to render services for a fee.
• Shirkah tul ‘Amwaal/Shirkah tul ‘Inaan: Partnership between two or more parties to earn profit
by investing in a joint business venture.
Musharakah Duration
Ongoing Musharakah: Most common form also referred to as open-ended or permanent. Partnership
where there is no intention of terminating or concluding the business venture at any point for
instance equity participation.
Partners may exit the business at any point they want. This is usually done by the remaining
partner(s) purchasing the share of the individual exiting the Musharakah.

Temporary Musharakah: Partnership created with the intention of terminating it at a given time in the
future at which point Musharakah assets are sold and distributed along with any remaining profit on
a pro-rata basis.
It is used to meet working capital needs of businesses, other examples being private equity followed
by planned exit.
Musharakah Capital
All Shariah–compliant items of material value may be used as capital in a Musharakah.
It may be in the form of cash or it may be in kind, for instance contributing assets to the business in
which case it is necessary to ensure the assets are valued at the time of Musharakah execution.
Partners’ capital investment ratio must be determined at Musharakah inception or before the
business generates profit.
In case of a Musharakah investment in different currencies, partners must agree upon the numeraire,
i.e. one particular currency to serve as the standard of value in the business which is usually the
currency of the country where the business is located.
Debt may not constitute Musharakah capital.
Musharakah Management
All partners possess the right to be involved in the administration of the business.
Partners who opt for limited partnership are silent partners. Since they do not participate in the
business unlike the working partners, according to Shariah, they cannot be allocated a profit share
greater than their capital contribution ratio.
The working partner is responsible for running the Musharakah but cannot receive separate
remuneration for his services although he may receive an increased profit share as a reward for his
management role.
Unlike for the silent partner, the working partner’s profit share may exceed his capital contribution
ratio.
In case an individual who is not a business partner serves as business manager, he is paid a fixed
wage for his services but does not share business profit or loss.
The business manager is liable for loss in case of his proven negligence.
If the business manager invests in the Musharakah business by means of a separate contract, his
capacities of manager and partner are independent of one another. He earns remuneration for his
managerial role and shares profit and loss based on his business partnership.

Musharakah Profit and Loss
It is important to remember that profits are not fixed in absolute terms, such as a number, or as a
percentage of the invested capital or the revenue.
For instance, $1,000 of profit cannot be stipulated as a fixed number at the time of the contract’s
execution because the profit itself is not yet known.
Or, for instance, if a person invests $100,000 and their profit is guaranteed to be 10% of their
investment amount. This would result in an absolute positive number, or $10,000, regardless of
whether the business gains or loses money.
Similarly, profit rates cannot be set as a percentage of the revenue either as if there’s no revenue;
how can there be any profit? And what if the revenue is unexpectedly high; why should investors be
denied higher profits?
In a Musharakah:
• Profit may not be guaranteed or fixed in absolute terms for any of the Musharakah partners.
• Profit may not be set as a percentage of capital.
• Each partner whether minority or majority shareholder must be allocated a profit share.
• One partner cannot guarantee any part of the profit or capital of another partner.
• Silent partner’s profit ratio may not exceed his investment ratio.
• During the Musharakah, a partner may surrender all or part of his profit share to another
provided doing so is not agreed at the time of Musharakah execution.
• Profit sharing mechanism and profit ratios must be clearly determined at Musharakah
inception.
• Musharakah may only announce an expected return for the business; actual returns are
declared only after they are known.
Profit Calculation
Profit is calculated by subtracting costs and expenses from revenue.
Loss can only be shared by capital contribution ratios.
In Practice
Many Islamic banks base profit and loss sharing investment or savings accounts on Musharakah. The
bank is the working partner and the account holders are silent partners.
Modern ijtihad has enabled a profit calculation system based on a combination of tiers of
investment amounts, investment duration, minimum and average balance.

Many businesses need running finance, but are unwilling to opt for finance on interest. In a
conventional running finance facility the bank offers credit to a client over a certain period and
charges interest. To address this, the bank and its client enter into a temporary Musharakah.
In a Shariah-compliant running Musharakah facility:
1. The bank and the client agree to a financing limit.
2. The bank opens a current account to hold the client’s sale proceeds and also to allow him to
utilize the finance facility.
3. The client’s contribution to the Musharakah is the business he owns, while the bank’s
contribution to the Musharakah are the running facility funds.
4. After a certain period, the client and the bank share the business’s operating profit based on a
predetermined ratio.
5. Eventually, one partner, the bank, sells shares to the remaining partner, the client, and exits the
Musharakah.
Unlike interest-based financing, where the bank is only interested in the repayment of a debt, in a
running Musharakah, the bank has actual equity ownership in the client’s business.
Negligence in Musharakah
Negligence refers to loss resulting from the violation of contract conditions or willful or intentional
damage to the Musharakah.
Musharakah Termination
If partners have not agreed on a Musharakah term, one of them may terminate his partnership
unilaterally at any time.
Alternatively, a condition may be stipulated at contract execution that no partner can terminate the
contract without the consent of the other partners.
In case of Musharakah termination, if assets are realized as cash, they are distributed based on
partnership ratios. In case a profit has been earned, it is distributed based on predetermined profit
ratios.
Tangible assets may be liquidated by granting them to existing partners in exchange for the profit
they have earned or they may be sold in the market and the income from them distributed.

CIFE05, 06, 07:

UNDERSTANDING MUDARABAH –
ISLAMIC INVESTMENT PARTNERSHIPS
Where Islamic banks meet
conventional private equity type
investing. Here you learn Mudarabahs,
the Islamic business partnership
where one partner supplies capital for
the business and the other provides
management expertise. We explain the
Mudarabah structure and contrast it
with Musharakah and Wakalah,
explaining how they differ in banking
practice. How is an investment
partnership different from an agency
contract? We discuss the relative merits of the Mudarabah and the
Wakalah structure in different situations. We also describe the Mudarib's
role, the duration of Mudarabahs and the forms of capital contribution by
the investor and in some cases even the Mudarib. We discuss the
Mudarabah's management and the rules for sharing profit and loss. We
also look at some practical examples showing how Islamic banks use
Mudarabahs.
A Mudarabah is a partnership between two or more parties usually to conduct business or trade.
Typically, one of the parties supplies the capital for the business and the other provides the
investment management expertise.
The financier or the Rabb al Maal provides all the investment capital for the business.
The investment manager or the Mudarib is entrusted with the Rabb al Maal’s capital, invests it in a
Shariah-compliant project and takes full management responsibility.
The Rabb al Maal and Mudarib share profit based on pre-agreed ratios.

Types of Mudarabah
With respect to the scope of business activity, Mudarabahs may be unrestricted or restricted.
Unrestricted Mudarabah
The Mudarib is free to invest capital in any Shariah-compliant project of his choice.
Restricted Mudarabah
The Mudarib’s investment of capital is restricted to specific sectors and activities and/or geographical
regions only. Here too, all investments must be Shariah-compliant.
Investment of Mudarabah Capital
1. More than one Rabb al Maal
2. Mudarib also contributes capital
3. Mudarib invests business capital in a different project
More than one Rabb al Maal
Multiple capital providers pool in their contributions to the same project and hire an investment
manager as Mudarib.
Mudarib also contributes capital
The Mudarib is permitted to contribute capital to the Mudarabah provided that the Rabb al Maal/
Arbaab al Maal approve.
Mudarib invests business capital in a different project
The Mudarib as business manager is responsible for investing and managing the Rabb al Maal’s
funds, however, the Shariah permits him to use the capital for parallel investments (i.e. receive
capital for Mudarabah and invest in a different venture).
Differences Between Mudarabah and Musharakah
1. In a Mudarabah, the Mudarib is solely responsible for managing the business, whereas in a
Musharakah all partners have the right to participate in the business.
2. The Rabb al Maal provides the business capital and only on condition that the Rabb al Maal
agrees can the Mudarib contribute capital to the Mudarabah whereas in a Musharakah all
partners must contribute capital.
3. Rabb al Maal bears any loss to the business provided it is not due to the Mudarib’s negligence,
however, in a Musharakah all partners bear loss pro-rata to their capital contributions.

4. Mudarabah costs that relate to tasks that pertain to the Mudarib’s domain are not billed to the
Mudarabah business; only running costs are whereas in a Musharakah, partners bear all costs
as they are subtracted from revenue prior to profit distribution.
5. The Mudarib may only receive the amount of capital that he requires to invest in the business
whereas in a Musharakah, when the business project concludes, the partners retain the right to
receive Musharakah capital according to capital contribution ratios.
Similarity between Mudarabah and Musharakah
1. The Mudarib is permitted to surrender all or part of his profit to the Rabb al Maal provided it is
not pre-agreed. Similarly in a Musharakah, a partner may give up his profit in favour of another
on the strict condition that it is not predetermined.
Differences between Mudarabah and Wakalah
1. The Mudarib in a Mudarabah receives a share in profit whereas the Wakeel or agent in a
Wakalah receives a fixed fee for services.
2. The Mudarib gets paid his profit share only if there is profit whereas the Wakeel receives a fee
in any case.
Similarity between Mudarabah and Wakalah
1. Both Mudarabah and Wakalah are principal-agent contracts and profit is not guaranteed in
either case.
Mudarabah Duration
Ongoing: Partnerships where there is no intention of concluding the business venture at any known
point, however, partners have the option of exit provided they give prior notice to the other partners.
Temporary: Partnerships created with the specific intention of terminating them at a given future
point in time. When the time is over, the Mudarabah assets are sold and distributed with any
remaining profit on a pro-rata basis.
Mudarabah Capital
All Shariah-compliant items of material value may serve as Mudarabah capital. The capital may be
cash or in kind. In case it is in kind it is important to ensure that the assets are valued at the time of
Mudarabah’s execution.
Partners’ capital investment must be established at Mudarabah execution or at the latest before the
business generates any profit. If partners are investing in different currencies it is important to agree
upon one particular currency or numeraire to serve as a standard value for the business.
Debt cannot serve as Mudarabah capital.

Partners may agree on individual profit shares.
For the Arbaab al Maal, the ratios of capital contribution may help them in developing their profit
sharing ratios but in practice these profit sharing ratios differ from capital contributions ratios.
Example:
A furniture business is set up between one Mudarib and one Rabb al Maal.
The Rabb al Maal contributes $5,000 cash. There are no other assets at this point.
The annual profit sharing ratios are agreed at 60% for the Rabb al Maal and 40% for the Mudarib.
The profit in the first year is $10,000 which is distributed as $6,000 for the Rabb al Maal and $4,000
for the Mudarib.
Mudarabah Management
Only the Mudarib possesses the right to manage the business.
The Rabb al Maal/Arbaab al Maal serve in the capacity of silent partners.
While restricted Mudarabahs are permitted, no conditions that may restrict or impede the Mudarib’s
management of business are allowed.
As business manager, the Mudarib receives a profit share for his effort however he is not entitled to a
fixed remuneration for his services.
If the manager wants to receive a fixed wage he must be employed under a Wakalah contract as
Wakeel, in which case he does not receive a profit share.
If the Mudarib is permitted by the Rabb al Maal/Arbaab al Maal to invest in the business, then by
means of a separate contract he may make an investment contribution and become a Rabb al Maal.
It is important to remember that his roles as Mudarib and Rabb al Maal are independent of one
another.
Mudarabah Profit Sharing
The profit sharing mechanism and mutually agreed profit ratios must be clearly defined for all the
partners at the Mudarabah’s inception or before profit or loss is generated.
Profit amount cannot be guaranteed or fixed in absolute terms for any of the Mudarabah partners
and neither can it be a percentage of capital.
A partner may voluntarily surrender all or part of his profit share to another partner provided it is not
pre-agreed at contract execution.
Loss in a Mudarabah
The Rabb al Maal/Arbaab al Maal bear(s) the entire loss based on capital contribution ratios.

The Mudarib does not bear any loss except that caused by his proven negligence.
Mudarabah Termination
A Mudarabah may be terminated by any party at any time provided the terminating party gives prior
notice however a ‘lock-in’ clause may be established for a certain period that the Mudarabah must
remain in operation unless unexpected circumstances such as death or injury materialize.
At termination, business assets in the form of cash are distributed based on capital contribution for
cash and profit sharing ratio for profit. If the business capital is in illiquid form, it is realized in cash.
Next after calculating accrued profit, the cash and profit are distributed as per capital contribution
and profit sharing ratios.
Mudarabah – Practical Applications at the Islamic Bank
Islamic banks collect money from their depositors on a Mudarabah (or Musharakah) basis and then
form a Mudarabah (or Musharakah) pool.
The bank serves as Mudarib to manage the pool.
Based on its contractual agreement with its account holding customers, the bank retains the right to
invest in the Mudarabah (or Musharakah) pool if it wants to.
The bank uses the capital to make a range of Shariah-compliant investments.
Operationally there is one difference, where normally profit in partnership based ventures like
Mudarabah are shared after costs have been deducted from the revenue, since it is difficult for
Islamic banks to identify and allocate costs to different pools and projects, they absorb the costs and
instead share gross profit.
Mudarabah accounts are usually offered through savings or term deposit accounts where normally a
longer duration of deposit corresponds to a higher expected profit rate.
Such accounts have ‘expected’ profit rates attached with them. These are the rates the account
holders can expect to receive.
It is important to remember that the bank cannot guarantee its rates of return.

CIFE08, 09:
UNDERSTANDING IJARAH –
ISLAMIC LEASING
What is an Islamic lease? This module
helps you find out. We introduce
Ijarah, the Islamic lease, and look at
the prerequisites for their execution,
legal title, possession, maintenance,
earnest money, default, and insurance.
We begin answering the question
"How does an Ijarah work?" with step-
by-step practical explanations. You
learn the rights and obligations of the
lessor and the lessee and focus on
defective assets, sub-leases,
extensions and renewals, transfer of ownership, and termination.
Ijarah is the lease of a specific asset or service to a client for an agreed period of time in exchange
for rent which at the end of the lease period may result in transferring the subject matter’s ownership
to the lessee.
Types of Ijarah
• Ijarah tul Aamaal
• Ijarah tul Manafaay
Ijarah tul Aamaal:
A lease contract providing services in exchange for agreed rent. For instance, the services of a
lawyer purchased by a client in return for a fee.
Ijarah tul Manafaay:
A lease contract executed to transfer the benefits of an asset in exchange for an agreed price. For
instance, an apartment leased for a year in exchange for a monthly rent. A part of the year’s rent may

be paid in advance and the remainder be paid as monthly installments, mutually agreed upon
between the lessor and lessee.
Usufruct lease categorized as:
• Specific Asset Lease: A particular asset. For instance, a car identified by the lessee, a red fully
loaded, automatic sedan.
• Lease of asset based on specifications: An asset not specifically identified by the lessee but one
required to meet certain conditions. For instance any sedan.
Ijarah classification based on transfer of ownership to lessee
Standard Ijarah
A lease contract where the lessee benefits from the asset for a specific time period but it does not
result in the eventual transfer of ownership of the asset to the lessee.
Ijarah wa Iqtina
A lease contract conducted solely to transfer ownership of the leased asset to the lessee at the end of
the lease period.
Ijarah prerequisites
The client and lessor enter into a promise to execute an Ijarah for the usufruct of a particular asset or
service. The institution undertakes to provide the asset or service and the client undertakes to enter
into a lease contract for it. The asset or service must be owned by the lessor and made available to
the lessee before the Ijarah commences. The lease period commences once the subject matter of the
lease is made available to the lessee.
Ijarah - Key Elements
Subject Matter
All Shariah-compliant assets or services may be used as Ijarah subject matter.
Legal Title
Generally the lessor owns the leased asset and it should be in his name however for regulatory
reasons the asset may be registered in the lessee’s name.
Possession
Ijarah may only be executed for subject matter the lessor owns and possesses.

Maintenance
Periodic Maintenance: The lessee is responsible for regular maintenance of the leased asset.
Major Maintenance: The lessor is responsible to meet all requirements to ensure the leased asset
continues to provide intended use.
Earnest Money
A sum of money the lessee deposits with the lessor. The lessor maintains it as compensation for
actual loss in case the client goes back on his word about executing an Ijarah. If the client fulfills his
undertaking to lease and enters into an Ijarah contract, the lessor returns him the earnest money.
Insurance
The Ijarah asset can be insured by means of Shariah-compliant Takaful insurance.
Ijarah Rent and Remuneration
Rent
1. Rent must be clearly defined, it may in the form of cash or kind or an asset’s usufruct.
2. Different rentals may be established for different periods.
3. Rent for the initial Ijarah period must be established and received in advance from the lessee
and rent for the remaining period may be linked to a well known benchmark.
4. Rent begins to accrue as soon as the subject matter of the lease is made available to the lessee.
Remuneration
Remuneration for a service is established in relation to time.
Default in Ijarah
Default in an Ijarah is a failure on the lessee’s part to make a rental payment.
If the lessee defaults on lease payments, the lessor may reclaim the asset or grant him respite until
his financial condition improves.
Lessor’s Rights and Obligations
Lessor’s Obligations
1. Lessor bears all the risks associated with the leased asset during the lease term.
2. Lessor takes care of major maintenance expenses and insurance costs. The lessor may include
insurance costs at the time rentals are determined however once rentals are established, they

may not be adjusted to accommodate a change in expenses. Lessor may appoint client as agent
to deal with the insurance company.
3. The lessor is obliged to deliver the asset and all associated leased items necessary to transfer
usufruct to the lessee. The lessor must rectify any problem that prevents the lessee from utilizing
the usufruct.
Lessor’s Rights
1. In case the lessee defaults on lease payments, the lessor is within his rights to reclaim the
leased asset or grant respite for a time. He may also charge a late payment fee which includes
administrative charges that belong to the lessor and a late payment penalty that is given to a
designated charity.
2. In case of excessive damage to the leased asset, the lessor may rescind the Ijarah.
3. The lessor may contract an Ijarah with more than one lessee for the same asset for different time
periods.
4. The lessor may rescind the contract if he becomes aware of the lessee’s intent to use the Ijarah
asset for unlawful purposes.
Lessee’s Rights and Obligations
Lessee’s Obligations
1. Lessee must utilize the Ijarah asset according to customary practice by which similar assets are
used. He must take necessary measures to preserve it from damage or defect and benefit from
the usufruct as provided in the contract and not in any way beyond its scope.
2. The lessee is obliged to pay rentals once the Ijarah’s subject matter is made accessible to him. If
the Ijarah asset is available to the lessee only for a part of the contract’s duration, the lessee is
not obliged to pay rentals for the period the usufruct is not at his disposal.
Lessee’s Rights
1. The lessee is within his rights to rescind the Ijarah contract if the lessor refuses to repair the
Ijarah asset’s defects that occur after the contract date or exist on the contract date
unbeknownst to the lessee.
Sublease
The lessee may sublease the Ijarah asset to a third party with the lessor’s consent.

Ijarah Renewal
The Ijarah may be extended when it reaches maturity if the lessee still wants to continue benefiting
from it. A new Ijarah is not required.
Transfer of Ijarah Asset Ownership
In order to transfer the Ijarah asset’s ownership to the lessee at the end of the lease term, a separate
document independent of the original Ijarah contract is prepared. In this document the lessee
undertakes to purchase the Ijarah asset at the end of the Ijarah period for a mutually agreed amount
at the time of Ijarah contract execution.
The price may be the actual cost of the leased asset or any other nominal value. Alternatively the
lessor may gift the leased asset to the lessee at the end of the Ijarah period.
In some cases, with the lessor’s consent, the lessee may even purchase the asset during the lease
period by making complete payment of rentals due or paying for the market value of the asset at the
time. The asset is sold to the client at the end of the lease period based on a separate sale contract
that represents the transfer of ownership.
Negligence in Ijarah
Negligence is the loss that results from the violation of contract conditions.
If the Ijarah asset is damaged as a result of the lessee’s negligence, he must bear repair expenses.
However the lessee is not liable for rent for the period the asset remains out of use.
Ijarah Termination
The Ijarah is terminated:
• Based on contractual terms
• One of the party’s rescission
• Due to the theft or destruction of the Ijarah asset’s usufruct.
As a general rule, contracts cannot be terminated unilaterally but only by mutual consent, however
there are some conditions as a result of which contracts are automatically terminated:
1. If the lessee fails to meet lease terms
2. If the lessee loses his sanity during the lease period
3. In case of the lessee’s death

Lessee can terminate the Ijarah:
If the Ijarah asset contains or develops defects. He may return the asset to the lessor and demand
compensation for the period of defect. The lessee may not rescind the contract if the defect does not
hinder usufruct utilization or the lessor ensures its immediate replacement.
Remember that the lessee can exercise rights of rescission in an Ijarah of a specific asset only.

CIFE10, 11, 12:

UNDERSTANDING MURABAHA –
COST PLUS FINANCING
Learn about the most widely used
Islamic finance product: buy an asset
for the customer; sell the asset at a
premium in installments to the
customer. That's a Murabaha. In these
modules we introduce Murabahas and
walk you through the steps necessary
for a Murabaha's valid execution. We
go on to discuss common mistakes
bankers make when executing
Murabahas and how to avoid them.
We also look at risk management,
default, early repayment, and profit calculation in Murabahas. And how
does it work in the real world? We look at 6 practical examples of
Murabahas based on installment repayments, bullet repayments,
advance payments, and credit and import Murabaha.
A Murabaha is a sale in which the seller’s cost of acquiring the asset and the profit earned from it are
disclosed to the client or buyer.
Islamic banks offer the Murabaha to fulfill asset purchase requirements and not as a liquidity
financing facility.
Murabaha Prerequisites
Subject Matter
1. Murabaha subject matter or the Murabaha asset must exist at the time of contract execution.
For instance a Murabaha can be executed for a car that exists not for one that is to be
manufactured.
2. The bank must own the asset and have either physical or constructive possession.

3. The subject matter must be an item of value and Shariah-compliant.
4. The subject matter must be a tangible good, clearly identified and quantified.
For instance, if the buyer wants to purchase rice, its exact quality and quantity in terms of weight
must be clearly specified in the Murabaha contract to avoid gharar or uncertainty that leads to
dispute between contracting parties.
Price
1. The Murabaha asset cost must be declared to the client.
2. The cost refers to all expenses involved in the asset’s acquisition.
3. The asset’s price includes all direct expenses where the bank pays for all indirect expenses.
4. Parties to the contract establish a profit rate by mutual consent or in relation to a specific and
known benchmark.
5. The Murabaha price may be charged at spot or be deferred and paid as a lump sum at the end
of the contract or in installments on fixed dates during the term.
6. The Murabaha profit must be disclosed as a specific amount.
It is important to remember that the Murabaha’s execution must adhere to a certain sequence of
procedures in order to ensure Shariah-compliance.
Steps of Murabaha Execution
1. The client’s submission of a purchase requisition for Murabaha goods:

Based on the requisition the bank approves the credit facility before entering into an actual
agreement.
2. The Master Murabaha Facility Agreement between the financial institution and the client. It
includes:
i. An approval of the client’s credit facility
ii. The terms and conditions of the Murabaha contract
iii. Murabaha asset specification
iv. Client’s undertaking to purchase the Murabaha asset once the bank acquires it (if not
included in the MMFA, it constitutes step 3)
3. The client’s unilateral promise to purchase the Murabaha goods and the financial institution’s
acceptance of collateral. At this stage the bank in order to safeguard its rights in case the client
backs out from entering into a Murabaha, requests the client to furnish a security or earnest

money called Haamish Jiddiah. In case the client backs out from entering into a Murabaha, the
bank makes up for the actual loss from it and returns the remainder to the client.
4. The agency agreement between the financial institution and the client or a third party
Since banks do not possess the expertise or manpower to purchase the asset, they appoint the
client as the agent to procure the asset from the supplier on their behalf.
Agency agreements are of two types:
Specific Agency Agreement: Agent is restricted to purchase a specific asset from a specific supplier
Global Agency Agreement: Agent may purchase the asset from any source of his choice. Such an
agreement also lists a number of assets which the agent may procure on the bank’s behalf without
executing a new agency agreement each time.
Key points to remember about the agency
• During the agency stage, the bank’s exposure to asset risk is highest and it is in the bank’s
interest to shorten this period as much as possible.
• Bank may also minimize risk by ensuring the supplier receives payment for the Murabaha asset.
• Bank must also ensure that the Murabaha asset to be purchased is not already in the client’s
possession. To maintain correct sequence, the bank must disburse the money to the agent
before the agent purchases the goods.
• The agency agreement is not a prerequisite but motivated by logistical ease.
• Banks can procure Murabaha goods directly or establish a third party agency.
5. The possession of the Murabaha goods by the agent on behalf of the financial institution. After
the agency agreement the client completes the purchase order form. The bank disburses the
money to the client, who as agent pays it to the supplier and receives possession of the
Murabaha goods.
6. The exchange of an offer and acceptance between the client and the financial institution to
implement the Murabaha sale. Either party can make the offer; the client may offer to buy the
Murabaha goods or the bank may offer to sell them. The Murabaha sale is completed at the
time of offer and acceptance.
7. The transfer of possession of Murabaha goods from the financial institution to the client. The
client is the owner of goods and all the associated risk and rewards however his obligation
does not conclude until he makes complete payment of the Murabaha price.

Mitigating Murabaha Risks
• The Shariah validity of a Murabaha is strongly sensitive to following the designated steps in the
correct sequence.
• A deferred Murabaha may not be executed for mediums of exchange (i.e. commodities such as
gold, silver and currencies). Only a spot Murabaha may be executed for them.
• The bank must seek Shariah-compliant Takaful insurance for Murabaha goods to cover transit
period risk (i.e. the risk posed to the bank once it purchases the goods from the supplier and
has their possession and before it sells them to the client).
Default in a Murabaha
There is no concept of a late payment penalty in a Murabaha contract, however, a charity clause is
established at contract execution to serve as a deterrent to default.
In case of a default in payment, based on the charity clause, the client is obliged to pay a
predetermined amount to a designated charity.
Murabaha Prohibitions
A roll-over is the provision of an extension in return for an increase in the original payable amount
and is impermissible in a Murabaha.
It constitutes repricing and rescheduling:
Repricing is prohibited because the Shariah does not permit an increase in debt once it is fixed.
Rescheduling is only permissible when the creditor provides an extension to ease the burden of a
debtor, so a roll-over where the bank increases the debt in return for an extension is impermissible
as the resulting amount of debt is analogous to riba or interest which is prohibited in Islam.
Calculating Murabaha Profit
From an accounting perspective, there are two stages in a Murabaha:
1st stage: The investment stage - Begins after the bank and client sign the agency agreement. It is the
time period where the bank has disbursed money for the purchase of the asset from the supplier but
has not yet acquired possession in order to sell it.
2nd stage: The financing stage - This stage begins when the bank receives the asset and goes ahead
with the exchange of offer and acceptance with the client. It ends once the bank receives the
Murabaha payment from the client. It is during this time that the bank has the right to accrue profit.
Example
A bank extends an advance for Murabaha to the client on the 1st of March, knowing that he will not
purchase the asset until the 1st of June.

The client purchases the asset on the 1st of June and the Murabaha sale takes place between him
and the bank on the same day.
If the tenure of the Murabaha is 4 months, it will commence on the 1st of June and last until the 1st
of October.
The bank will begin calculating profit on the 1st of June and not the 1st of March so that no income
accrues to the bank between 1st of March and 1st of June.
In case the client as agent is unable to purchase the asset on the 1st of June due to some
unavoidable circumstances such as a supply shortage and the Murabaha is terminated, the bank is
entitled to receive only the capital back and nothing more.
This is the key difference between a loan on interest and a Murabaha.

CIFE13, 14, 15:

UNDERSTANDING SALAM AND ISTISNA –
FORWARD SALE AND MANUFACTURING
CONTRACTS
What makes a forward contract
Islamic? Learn here. In this module on
Salam, the Islamic forward sale, and
Istisna, the Islamic manufacturing
contract, we begin with Salam. We
look at the goods for which a Salam
may be executed, the prerequisites,
and the use of a Parallel Salam. We
discuss security, replacement, and
default before explaining how its
pricing is calculated. We then look at
Istisna and discuss the major
differences between it and the Salam. We also discuss delivery, default,
and termination in an Istisna. We conclude the 3 module series with a
practical product structuring exercise where you get to choose the
appropriate financing tools in a given scenario.
Salam is a sale where the price of the subject matter is paid in full at the time of the contract’s
execution while the delivery of the subject matter is deferred to a future date. It is not necessary that
the subject matter exist, and be owned and possessed by the seller at the time of the Salam’s
execution as is the customary requirement of a standard sale, provided it meets the other criteria
specific to it. Salam is a mode of finance that helps the seller generate and utilize liquidity and at the
same time allows the buyer to purchase commodities for a price lower than the spot market price.
A Salam may be executed for homogeneous commodities but not for specific commodities and
mediums of exchange.
Homogeneous commodities, also termed fungible, are similar to one another and are sold as units.
The difference between them is negligible. Since they are homogeneous, in case of loss, one unit
may be replaced by another.

Salam Prerequisites
1. The quantity and quality of Salam goods must be specified in order to avoid any ambiguity that
may lead to dispute between contracting parties. Salam goods must be readily available in the
market so that at the time of delivery if they do not meet specifications the seller can procure
them easily and supply them to the buyer.
2. Salam price must be paid at spot. The price is fixed and cannot be increased due to an increase
in the price of Salam goods in the market during the contract’s term. The seller must deliver the
goods without demanding any excess money as the Salam goods become the property of the
purchaser once the contract is signed.
3. The place of delivery of Salam goods must be specified and they must be delivered in their
entirety on a fixed future date or in installments on predetermined dates.
4. Salam goods cannot be sold to a third party before receiving possession however a parallel
Salam may be executed for them.
Parallel Salam
A Parallel Salam is a transaction executed simultaneously with the original Salam. The buyer of
goods in the first Salam is the seller of goods in the second or Parallel Salam.
For instance, a buyer makes a payment for the subject matter to be delivered at a date, three months
in the future.
At the same time, as a seller, he executes another Salam for a higher price with a third party for the
same goods to be received by him in the future. This way the money disbursed to purchase goods in
the first Salam is retrieved as price payment and profit from the parallel Salam. Once the goods of
the original transaction are delivered they are transferred to the buyer in the Parallel Salam.
A Parallel Salam is permitted with a third party only.
Salam Essentials
Price
Most things established as the price for an ordinary sale may also be established as Salam price (i.e.
cash, goods and usufruct).
It is important to remember that goods may serve as the Salam price provided they do not fall into
the Amwaal e Ribawiya category.
Usufruct refers to the benefits received from a particular asset. The buyer in a Salam may offer the
seller an asset’s usufruct for a specific time period as the Salam price.
The Salam price is determined based on the number of days the bank’s funds remain invested in the
Salam transaction.

Subject Matter
1. The subject matter must fall into the category of homogeneous goods and be easily available in
the market throughout the contract’s term or at the time of delivery.
2. The subject matter must be clearly specified in terms of quantity and quality.
3. The subject matter must not be a commodity for which value cannot be established. For
instance precious stones.
4. The Khayar al Aib (option of defect) may be exercised for Salam subject matter, however, not
the Khayar al Rooyat (option of refusal).
The Khayaar al Aib is an option that a buyer may exercise to return goods to the seller if they are
found to be defective according to the specifications at the time of delivery.
The Khayaar al Rooyat is an option of refusal based on which the buyer may decline from accepting
the goods as a result of non-conformity to specifications.
Delivery of Salam goods
1. The date of delivery of the subject matter must be clearly established at the time of the
contract’s execution.
2. The place of delivery of the Salam goods must also be clearly specified.
3. The delivery of the subject matter implies the complete transfer of its ownership.
Salam Termination
Once executed, a Salam may not be revoked unilaterally by either party. It is a sale contract binding
on both parties and may be terminated completely or partially by mutual consent by returning the
actual or proportionate amount of the price paid.
Salam Term
A Salam may be executed for any length of time mutually agreed upon between the buyer and the
seller.
Security in a Salam
Since Salam is based on advance payment, the buyer is within his rights to obtain a form of security
from the seller. In case of default, the buyer liquidates the security and makes up for the actual price
paid for the subject matter.

Alternatively at the time of contract execution, the buyer may establish that in case of default, he
will sell the security in the market and purchase the goods that the seller was supposed to provide at
their going rate. The seller will then make up for the price difference if any.
Replacement of Salam Subject Matter
Salam subject matter cannot be replaced before the delivery date however it may substituted for
another commodity based on mutual consent and the observance of some conditions.
Delay in Delivery of Salam Subject Matter
In case the seller is unable to deliver the subject matter on time, the buyer may not charge a penalty,
however, a charity clause established at the time of contract execution serves as a deterrent against a
delay in delivery.
Default in Salam
Default in a Salam may be intentional or unintentional.
Unintentional
If the seller is unable to meet delivery due to unavailability of goods or a price rise:
• The buyer may wait for the commodity to return to the market or
• Both parties can mutually agree to terminate the contract and the buyer may be reimbursed the
entire payment or
• Both parties may mutually agree to replace the original subject matter with another commodity
Intentional Default
In the case where the seller deliberately does not purchase the commodity from the market to avoid
a personal loss, he must be compelled to follow through with the original commitment or else the
buyer may liquidate the security to make up for loss.
Salam: Practical Application
The price of goods in a Salam may be fixed at a lower rate than the price of goods delivered at spot.
The difference between the two prices earns the financial institution a legitimate profit.
The Islamic bank after purchasing the commodity may sell it through a parallel Salam contract for
the same delivery date.
If a parallel Salam is not feasible, the Islamic bank may obtain a promise to purchase from a third
party.

Istisna
An Istisna is a transaction used to acquire an asset manufactured on order. It may be executed

directly with the supplier or any other party that undertakes to have the asset manufactured.
There are usually two parties involved in an Istisna contract; the Istisna requestor, or orderer, and the
manufacturer.
An Istisna takes place when one party agrees to manufacture a product for another party at a specific
price. This agreement involves an exchange of an offer and an acceptance which completes the
contract.
Subject Matter in an Istisna
1. The subject matter of an Istisna need not exist, be owned or possessed by the manufacturer at
the time of contract execution.
2. It must be an item that is manufactured as customary market practice and undergoes processing
to convert from one form to another.
3. The manufacturer cannot execute a pre-agreed Istisna for goods that he already possesses.
4. The Istisna subject matter must be clearly specified.
5. The manufacturer and not the Istisna requestor must procure the subject matter.
6. Unless the requestor stipulates otherwise, the manufacturer may also have the goods produced
from another source.
7. The quantity or quality of Istisna subject matter can be changed by mutual consent of the
contracting parties.
8. The Istisna requestor reserves the right to exercise the Khayar al Aib after receiving the delivery
of Istisna goods within a certain time limit the manufacturer specifies.
Istisna Essentials
1. Cash, goods and usufruct may serve as the Istisna price.
Goods may be established as the Istisna price provided they do not fall into the category of
Amwaal al Ribawiya.
2. Istisna price may be paid at the time of contract execution, in fixed installments over the
contract’s term or as a lump sum at the end of the contract’s term.
3. The Istisna price is mutually agreed upon between the Istisna requestor and manufacturer at the
time of contract execution.
4. The Istisna price may not be established on a cost plus profit basis like a Murabaha but as a
lump sum.

The manufacturer need not pass on the benefit of a lower manufacturing cost to the requestor and
conversely if the manufacturing cost turns out to be greater than the estimate, he must bear it.
Istisna Term
An Istisna may be executed for a time period mutually agreed between the Istisna requestor and
Istisna manufacturer. In case a time period is not agreed upon, the goods may be manufactured and
delivered within a reasonable period of time as is the market norm for those goods.
Parallel Istisna
A parallel Istisna is a second Istisna contract executed alongside the first Istisna. The manufacturer in
the original contract serves as the Istisna requestor in the parallel contract and profits from a
difference in price. The parallel Istisna is completely separate and independent of the original Istisna
contract.
For instance a client places an order for the manufacture of goods with an Islamic bank, the bank
enters into an Istisna with the manufacturer.
Once the bank receives the goods, it transfers them to the client.
As the client is the ultimate buyer, the bank may appoint him as an agent to supervise the
production of the Istisna goods.
It is important to remember that the bank may not enter into an existing Istisna contract between two
parties.
Default in Istisna
The Islamic bank may demand security in its capacity as requestor or manufacturer. Such a security
is called Arbun. Arbun is a non-refundable down payment that the seller/manufacturer receives from
the buyer/requestor, in order to secure the purchase of goods.
Delivery of Istisna Goods
1. The buyer may not consume Istisna goods before they are delivered. The buyer must first
assume physical or constructive possession of the goods.
2. If Istisna goods do not meet specifications and are of an inferior quality, the buyer can reject
them however if they are of superior quality he must accept them unless he requires them as
raw material.
3. The buyer may accept Istisna goods of an inferior quality if the manufacturer agrees to reduce
their price.
4. In case of early delivery, the buyer may accept it provided it does not adversely affect his prior
arrangements.

5. If the buyer delays accepting goods delivered on time, the manufacturer may charge him for the
expense for holding them on his behalf.
6. If the buyer refuses to accept goods, the manufacturer may sell the goods as agent on the
buyer’s behalf. Any amount above the original price is returned to the buyer and if goods sell
for a lower price, the buyer is expected to pay the difference.
Shart al Jazai
A penalty established at the time of contract execution that allows for a reduction in the price of
manufactured goods in case of a delay in their delivery. Such a penalty is only permitted in
manufacturing contracts as the buyer requires the goods at a fixed time and in the absence of a
deterrent, a delay in delivery could have serious consequences with respect to follow-on
commitments.
Rebate in an Istisna
The manufacturer is permitted to grant the Istisna requestor a rebate in the price at his own
discretion. A rebate may not be stipulated at contract execution.
Prohibition of Buy-Back
The Istisna must not involve a buy-back at any stage. Before the Istisna is executed it is important to
ensure that the contracting parties are separate and independent legal entities.
Istisna Termination
Either of the two contracting parties may terminate the Istisna unilaterally provided the
manufacturing process has not commenced. If manufacturing has begun then the contract is binding
on both parties and can only be terminated by mutual consent.
Istisna: Practical Applications
An Istisna can be used to finance construction, export and infrastructure development.

CIFE16:
UNDERSTANDING TAKAFUL –
ISLAMIC INSURANCE
You lear n the difference
between Islamic and
conventional insurance and
the essentials that make
Islamic insurance unique.
Islamic Insurance is based on mutual
assistance and co-operation through
voluntary contributions to a common
fund that provides its members mutual
indemnity in the event of loss.
Prohibition of Conventional Insurance
Conventional insurance is prohibited as it possesses the following elements:
• Gharar: Contractual uncertainty that leads to dispute.
Gharar exists in conventional insurance as one party in the contract, the insurer, has a right to
profit from the investment of insurance premiums and the other party, the insured, does not
have access to its funds.
• Maisir: The element of speculation in a contract.
In conventional insurance, the insured pays a premium expecting a much greater amount in
case of loss, but loses the entire premium when an uncertain event does not occur.
• Riba: Any amount that is charged in excess which is not in exchange for a due consideration.
Conventional insurance possesses the element of riba in two ways:
• It involves direct riba in terms of the excess that is involved in an exchange between the
insured’s premium and the insurer’s payment against a claim.
• It involves indirect riba based on the interest earned on interest based investments made by the
insurance company with the insured’s premium.

Differences between conventional insurance and Islamic cooperative insurance
Conventional Insurance Islamic Insurance
The conventional insurance contract is a The Islamic insurance contract is based on co-
purely financial contract involving uncertainty. operation and seeks mutual benefit through
contributions to a common fund.
The insurance company executes the contract The insurer serves as the insured’s agent to
in its own name. manage operations and invest premiums based
on Mudarabah. The insured has equity in the
pooled funds.
The insurer owns the premiums in return for The cooperative insurance account is the owner
being obliged to pay insurance claims of funds.
All the premiums after deduction of insurance Any surplus after deduction of expenses from
expenses are considered the insurer’s revenue. the premiums is distributed among the members
of the insurance fund based on their
contribution ratios or any other method agreed
upon in the insurance policy.
All returns from investment transfer to the The Mudarabah based return from investment of
insurer. premiums, after deduction of the Mudarib’s
share, belong to the fund members.
The insured and the insurer are two separate The insurer and the insured are the same;
entities; the seeker of insurance and its members of a mutual fund seeking to indemnify
provider. each other against loss. The participants pool
together their risk and their premiums to share
them.
Provides protection against speculative risk in Only provides protection against pure loss
addition to pure risk. exposures.
The amount left over in the insurance account The amount left over in the insurance account is
at the time of liquidation is kept by the disbursed to charity at the time of liquidation.
insurance company.
Speculative Risk
Speculative risk is the risk that involves the possibility of loss, no loss or gain. For instance, the risk
involved in a new business venture.
It is prohibited to insure speculative risk as it entails gharar with respect to the probability of gain as
well as that of loss.

Pure Risk
Pure risk involves the possibility of loss. For instance damage to property due to a fire. Such risk can
be insured Islamically as it does not involve uncertainty with regard to the probability of gain as well
as loss.
Islamic Insurance - Essentials
1. Islamic insurance offers risk protection based on Shariah principles of mutual co-operation.
2. It is offered on the principles of good faith where both contracting parties make full disclosure
of all relevant material facts without intending to manipulate, cheat or disadvantage each other.
3. Based on three main relationships, the Musharakah between participants of the joint fund, the
Wakalah between the Islamic insurance company and the insurance policy holders and a
Mudarabah between the insurance policy holders and the fund itself.
4. The insurer in his capacity as the agent cannot guarantee premiums and can only be liable in
case of his proven negligence.
5. The insurer and the insured must fulfill their responsibilities in the contract. This may include
conditions that do not affect the co-operative nature of the agreement.
6. The insurance company may charge a fee for its services as agent of insurance operations.
However, the returns from the investment of premiums in Shariah-compliant endeavours based
on the Mudarabah must be distributed between the insurer and the insured according to their
investment ratios.
7. In case of loss to members, the Islamic Insurance company may demand indemnity from the
party responsible for damage. Additionally, it may take all necessary action to receive the
insurance amount on behalf of its participants. Alternatively, the participants of the Islamic
Insurance company and the party causing the damage may even reconcile with one another
according to Shariah principles.
8. A Shariah advisory board must be established to supervise insurance operations and ensure
Shariah-compliance
Types of Islamic Insurance
There are two types of Islamic insurance:
• Property insurance; or insurance against injuries or mishaps such as fires, earthquakes, car
accidents and so on.
• Personal insurance; which refers to indemnity against the risk of disability or death, also known
as Takaful.

Islamic Insurance - Duration
Islamic Insurance requires both the insurer and the insured to adhere to certain time limits.
• The insured must make timely payment of premiums, if he doesn’t, the insurer is within his
rights to withhold indemnity, cancel the contract or alternatively take legal action and pursue
due payment from him.
• The insured must provide evidence for a claim within a stipulated period of time. On the other
hand, the insurer must follow through with providing timely and agreed upon indemnity for
loss to him.
• The insurance contract runs its course for a specified term before it expires. It is also terminated
upon damage to insured property or death of the insured, as in such cases the object of
commitment ceases to exist.
Islamic Insurance - Overview
Islamic Insurance funds are invested in a joint pool created to share risk and provide its members
mutual guarantee and protection against it.
The fund is managed by one of its members in exchange for a payment of a fixed fee or alternatively
a manager is hired for the job.
The operator manages the funds in the pool, maintains a part of the funds to pay for claims and
invests the rest in Shariah-compliant business ventures.
In case a loss is experienced by any member of the pool it is distributed equally amongst all its
participants and is made up for from the funds within the pool.
In the event of a profit from business investments, it is distributed among the investors according to
their investment ratios.
After the fulfillment of claims, if any, the operator is remunerated for his services from the amount in
the pool and the remaining balance is distributed among its members.
Re-insurance
A new insurance arrangement consistent with Islamic insurance principles and guidelines provided
by the Shariah board. It is enacted in the event that the amount in the original fund is insufficient to
meet the needs of its members.

CIFE17, 18:
UNDERSTANDING SUKUK –
ISLAMIC SECURITIZATION
Sukuks are Islamic shares and we
show you the main features walking
you through the 8 step structuring
process concluding with a study of
Ijarah Sukuk. We continue our
discussion on Sukuk with a look at
Musharakah and Mudarabah Sukuk
and the limitations of issuing using
Murabaha, Salam and Istisna. We
close with a case study of the IDB
Sukuk.
Sukuk is the Arabic plural of the word Sakk which means certificate. Sukuk are certificates of equal
value representing undivided shares in ownership of tangible assets, usufruct and services.
For instance, six partners invest in a business venture worth $60,000 by making an investment of
$10,000 each.
In order to represent their shareholding they create certificates to divide the business into 60,000
units.
Each partner is allotted 10,000 shares.
Securitization is the process of issuing certificates of ownership against an asset or business.

Securitization turns an ordinary asset into a tradable security.
If the securities represent a proportionate share of ownership in tradable assets, the trade of such
securities is permissible.
Important to remember:
The asset portfolio must consist of 25% tangible assets because if the majority of assets are liquid
and sold for any amount other than their face value, the transaction is analogous to riba.
The core contract used in the process of securitization to create Sukuk is the Mudarabah, based on a
predetermined profit sharing ratio, where one party serves as an agent on behalf of the principal
who is the capital owner.

The Mudarabah contract creates the Sukuk with the establishment of an independent legal entity
known as a Special Purpose Vehicle or SPV.
In the case of Sukuk, the SPV acquires Shariah-compliant assets and issues ownership certificates
against them.
8 Steps of Sukuk Issuance
1. The identification of assets to be securitized;
2. The creation of the SPV;
3. The transfer of the assets to the SPV;
4. The issuance of participation certificates against the identified assets;
5. The lease of the assets back to the seller;
6. The provision of a guarantee by an investment bank for future payments or to replace assets if
and when required;
7. Periodic payments to investors where there is income from the securitized assets;
8. The termination of the SPV at maturity by the sale of the assets to the original seller at a pre-
determined price and after paying any dues owed to the certificate holders or investors
Ijarah Sukuk
A Sukuk al Ijarah may be issued for 3 purposes:
1. To securitize ownership of a leased asset.
2. To securitize ownership of the usufruct of an asset.
3. To securitize ownership of the right to receive benefits from services.
Ijarah Sukuk issuance prerequisites
1. Ijarah Sukuk must represent the holder's proportionate ownership of the leased asset.
2. The Sukuk holder must assume the rights and obligations proper to a lessor to the extent of his
ownership.
3. As the owner, the Sukuk holder has the right to receive rent proportionate to his ownership in
the asset.
4. It is essential that the Ijarah Sukuk is designed to represent real ownership of leased assets, and
not only a right to receive rent.

Ijarah Sukuk Advantages
Pricing
Rentals amounts that are eventually transferred to Sukuk-holders may be fixed or benchmarked
against a known standard.
Reassignment
Ijarah Sukuk may be reassigned or sold to those seeking ownership in the secondary market
provided the underlying assets represent a considerable portion of tangible assets.
Maturity
The Ijarah may be executed for any length of time mutually decided between the lessor and the
lessee provided the subject matter of the Ijarah continues to exist.
Timing
The asset represented by the Ijarah Sukuk need not exist at the time of contract execution.
Equity Based Sukuk
Musharakah Sukuk
• Used to create new projects, develop existing projects and finance business activity on the
basis of a partnership contract.
Mudarabah Sukuk
• Based on the Mudarabah contract for which capital is received from investors to finance a
project.
• Sukuk are issued to investors to represent their proportion of ownership in the investment
activity.
• The investors earn profit from the business venture and may even sell their ownership share in
the secondary market.
Both Musharakah and Mudarabah Sukuk are bought and sold in the market where Sukuk-holders
share profits by an agreed ratio and losses in proportion to investment ratios. In a Mudarabah the
principal bears all loss.

To allow tradability, the asset portfolio of Musharakah and Mudarabah Sukuk should include 25%
tangible assets. Sukuk issuer cannot guarantee profits.
Sale Based Sukuk
Murabaha Sukuk
• Sukuk investors provide issuer with funding to purchase assets
• Asset is purchased from supplier
• Asset is sold to the issuer for a deferred price
• Profit earned is distributed proportionately among the investors
Important to remember:
These Sukuk represent the investors’ shares in receivables from the purchaser. And since these
receivables are a debt, they cannot be traded in the secondary market.
Salam Sukuk and Istisna Sukuk
Salam and Istisna Sukuk are a useful investment tool for a variety of short, medium and long-term
financings
For the issuance of Salam or Istisna Sukuk:
• An SPV is created, which buys a commodity such as crude oil in a Salam, or constructs
infrastructure such as a highway in an Istisna.
• The SPV pays the price of the crude oil, or cost of construction of the highway at the time of the
contract’s execution with the income generated from the sale of certificates to investors.
• After executing the Salam or Istisna, a promise is obtained from the ultimate beneficiary of the
deliverable to buy it from the SPV on the date that it is due.
• Since Salam Sukuk represent a debt in the form of Salam goods to be delivered at a specified
date in the future, they may not be sold in the secondary market. Istisnas, on the other hand,
gradually transform from a pure debt to a manufactured item, so once the item is substantially
created, where the timing depends on the asset and the opinion of the Shariah board, the
certificates are tradable.

CIFE19, 20:
LIQUIDITY MANAGEMENT IN ISLAMIC
FINANCE
What do Islamic banks do with excess
capital in the short term? How do they
access capital for the long term? You
learn the answers to these and other
questions in this module. We discuss
how Islamic banks manage liquidity
and begin by explaining an inter-bank
Mudarabah, walking you through how
a weightage table works. We close the
module with a look at the application
of Sukuk in liquidity management. You
look at filters for stocks, shares,
Musharakah investment pools, and the use of agency contracts to
manage liquidity. We also look at local and foreign currency Commodity
Murabahas.
Liquidity management refers to the financial management of an excess or shortage of funds. In order
to maximize returns and to ensure that funds are used efficiently, banks place their excess liquidity
somewhere for the time they do not require the funds, (sometimes even for a night) and when they
have a shortage of liquidity, they tap markets and other financial institutions for access to funds.
Liquidity Management Tools
Mudarabah
A Mudarabah is a business partnership between two or more parties, where one party supplies
capital and the other provides management expertise.
The objective of the Mudarabah deal is to provide a Shariah-compliant structure to conduct

permissible transactions in order to meet business needs and reserve requirements.

The basic structure for inter-bank dealings for managing liquidity is the implementation of the master
Mudarabah agreement conducted for a maximum period of 180 days, which discloses the profit and
loss sharing ratios between the partners as well.
In this way the master Mudarabah agreement serves as the basis for money market transactions
provided:
• The investor and working partner mutually agree on a profit sharing ratio at the time of contract
execution
• The investor is held liable for loss to the business venture when not caused by the working
partner’s negligence
It is a Shariah requirement to establish profit and loss sharing ratios at the time of Mudarabah
execution.
For the appropriate allocation of profit, weightages are assigned to each investment category,
whereas loss is shared in proportion to investment amounts.
Weightages are profit ratios. The longer the term of the deposit, or the higher the balance, the greater
the weightage allocated to it.
Steps of an Interbank Mudarabah Transaction
• Step 1: After the Mudarabah deal between the bank and investor the transaction is reported to
the financial institution’s treasury operations department.
• Step 2: The treasury department verifies the deal between both parties, confirms the
weightages, their conversion to expected profit rate and contract maturity date.
• Step 3: Based on the Mudarabah contract, the Islamic bank as working partner pays regular
profit to investors during the contract’s term.
At maturity the Mudarabah closes out the balance of profits and losses.
Sukuk
Sukuk are certificates of equal value representing undivided shares in the ownership of tangible
assets, usufruct and services. They are equity stakes in assets and companies, so unlike conventional
bonds, which are debt instruments, they are directly affected by profits and losses.
The process of issuing tradable certificates of ownership against assets, investment goods and
businesses is referred to as securitization.
The underlying instrument used in Sukuk ranges from commonly used Ijarah and Musharakah to
Mudarabah and hybrids that include Murabaha, Salam, and Istisna.
These Sukuk are floated on the capital markets and are available to institutions seeking a relatively
liquid means to park their capital while also receiving attractive returns.

Alternatively, in case of a shortage of funds, financial institutions sell Sukuk to generate the liquidity
necessary to meet requirements.
Shariah-Compliant Equities
Like investment in Sukuk, Islamic financial institutions also make investments in Shariah-compliant
equities in general provided they meet the Shariah-compliance criteria for stocks.
Musharakah Investment Pools
In order to handle a shortage of funds, Islamic banks create investment pools consisting of financing
assets based on Murabahas, Ijarahs and Diminishing Musharakahs. When necessary, these assets are
transferred from the general pool to the specific investment pool to fulfill short-term liquidity
requirements.
Musharakah Pool Creation Checklist
1. In order to ensure Shariah compliance, the pool must consist of at least 33% tangible assets.
2. The Islamic bank accepts funds in the capacity of working partner and investors serve as silent
partners.
3. The tenure of the pool must be less than or equal to the tenure of the financing assets it
comprises.
4. The pool must consist of those assets expected to earn a profit greater than the profit required
by the financial institutions making the investment.
5. The profit and loss sharing ratio established between the financial institution and the Islamic
bank must be the same that could be availed for an investment of an equivalent amount of
capital in another financial concern.
6. At maturity, the pool must be dissolved and the assets transferred back to the general pool.
When disbursed from the general pool, the assets must be appropriately assigned to a specific
investment pool.
The proper allocation of financing assets ensures that the profit earned from them is properly
attributed to the specific pool.
Agency or Wakalah
In a Wakalah, the bank possessing excess liquidity as principal, appoints another bank as its agent to
invest its money in various profitable, Shariah-compliant ventures.
The invested funds become a part of the treasury pool of the bank receiving the investment.

Before investing the funds in a business venture, the agent presents the principal with an offer for a
probable investment opportunity where it discloses the amount to be invested, and the tenure and
profit to be expected from the investment.
If the principal accepts the agent’s offer, the deal is executed.
An agency fee is fixed for each deal between the agent and the principal and when the realized
profit is greater than the amount expected, the agent is entitled to retain the amount that is in excess
in addition to the pre-agreed agency fee.
If the business venture suffers a loss as a result of the agent’s negligence, the principal is entitled to
the profit and any compensation for actual costs, expenses and the original investment.
Foreign Currency Commodity Murabaha
The foreign currency commodity Murabaha is commonly used for investing excess funds and is
available for maturities ranging from overnight to a period of a year.
In a commodity Murabaha, the Islamic bank purchases a commodity on spot and sells it based on a
deferred payment ensuring that the transaction is used only to manage liquidity.
• The Islamic bank with the surplus funds through a broker procures a metal listed on a metal
exchange in order to sell it to the Islamic bank short of funds.
• After purchasing the metal from the broker the Islamic bank maintains the amount payable to
him as foreign currency in a separate account.
• The metal is now sold to the bank in need of funds in exchange for a deferred payment through
a Murabaha sale. Having purchased the commodity, the bank in need of funds pays the
Murabaha price in foreign currency within 90 days.
• The selling Islamic bank discloses its cost for purchasing the foreign currency, the cost of the
metal from the broker, and the profit earned over the 90 days. The profit is linked with a money
market benchmark such as LIBOR.
• The bank short of funds sells the metal to a different broker than the one used earlier and
receives payment in foreign currency.
• This broker then sells the metal to the first broker.
• The Islamic bank makes the payment of metal’s price owed to the first broker in foreign
currency and this broker pays the second broker.
• The bank short of funds receives the metal’s price in foreign currency from the second broker
and, after 90 days, the selling Islamic bank recovers the foreign currency principal amount in
addition to a profit linked to LIBOR.

Local Currency Commodity Murabaha
The process involved here is different from a foreign currency commodity Murabaha because an
organized asset exchange market is not used.
Commodities like sugar, cotton and fertilizer are physically identified before a sale takes place.
• The Islamic bank appoints an agent who takes possession of the commodities on the bank’s
behalf. Whenever instructed, the agent sells out or issues a delivery order for the commodities
in favour of another person or party.
• The bank purchases a commodity from a broker at a spot cash price.
• Another commodity broker representing a financial institution requiring liquidity, issues a

delivery order to the Islamic bank’s agent. The agent checks the availability of the commodity
required by the delivery order and informs the Islamic bank.
• After taking delivery of the commodity from the agent, the Islamic bank sells it to the financial
institution on deferred payment. The price of the commodity is fixed based on a benchmark for
a matching tenure.
• The commodity is received by the financial institution and the buyer, now having taken
constructive possession of the commodity sells it.

CIFE21, 22:
RISK MANAGEMENT IN ISLAMIC FINANCE
Some have said "Banking is
risk management." If you don't
know anything about risk
management this is the
module for you. You learn the
basics about risk management
in Islamic finance and discuss
the most common risks facing
Islamic banks and the
mitigation techniques used to address them. Now you learn about how
risk relates to each specific Islamic finance product. We go through each
major Islamic banking product, namely Murabaha, Salam, Istisna, Ijarah,
Musharakah and Mudarabah, and explain the specific risks associated
with each.
Risk is defined as exposure to the likelihood of loss, where this loss takes on many forms depending
on the kind of risk involved. It is the possibility that the outcome of an action or event could bring
an adverse impact to the bank. Some of the many threats to a financial institution are low
profitability, bankruptcy, fraud, false financial reporting and mismanagement.
For a transaction to be Shariah-compliant, the main principle with regard to risk is that in order to
benefit, liability must be assumed.
Risk management is the process of evaluating and responding to the exposure facing an organization
or an individual. It is a structured and disciplined approach employing people, processes and
technology for managing the many uncertainties faced by an organization.
Forms of Risk
• Credit risk: Refers to the possibility of a counter party failing to meets its financial obligations
according to agreed terms. It represents 80% of the risk linked to a bank’s asset portfolio.
• Equity investment risk: Arises from entering into a partnership to finance a specific business
activity. Mudarabah, Musharakah and most Sukuk are susceptible to equity investment risk.
• Market risk: Represents the market’s volatility and its effects on an investment’s value

• Liquidity risk: Refers to the potential risk of loss to financial institutions arising from the
inability to meet financial obligations.
• Rate of return risk: Financial institutions are exposed to rate return risk in the context of their
overall balance sheet exposures. Increased benchmark rates may result in investment account
holders having increased expectations of higher rates of return.
• Operational risk: Refers to the risk of direct or indirect loss resulting from inadequate or failed
internal processes, people and systems.
• Legal or Shariah non-compliance risk: Relates to operational risk given the Shariah sensitivity
to mistakes in operations
Risk Mitigating Tools
Personal guarantees
Guarantees of different types, such as a guarantee for timely payment, a guarantee for supplying
goods at a specific time etc.
Pledges
A form of security, an asset or cash, taken from the client and maintained by the financial institution.
Earnest Money
Security the client deposits with the bank as security to serve as compensation in case he backs out
from entering into a contract.
Promises
The client undertakes to purchase goods from the financial institution in order execute a contract.
Agency Agreements
In order to ensure goods are procured according to specifications the financial institution may
appoint the client or a third party as agent for the job.
• Specific agency agreement
• Global agency agreement
Advance Payment
An amount paid at the time of contract execution and considered a part of the asset’s price if client
makes all payments within the agreed time period.

Options
Several options can be granted or possessed in order to mitigate risk in contracts.
For instance:
• Khayar al Shart – Optional Condition
• Khayar al Rooyat – Option of Inspection
• Khayar al Aib – Option of Defect
• Khayar al Wasf – Option of Quality
• Khayar al Ghaban – Option of Price
Takaful
An Islamic alternative to conventional insurance. Based on the concept of mutual indemnity in case
of loss.
Shart al Jazai
A penalty that allows for a reduction in price of manufactured goods in case of a delay in their
delivery. Such a penalty is permitted in manufacturing contracts.
Charity Clause
The charity clause serves as a deterrent to default, based on it the client undertakes to give a certain
amount to charity in case of default in payment.
Risks in Murabaha
• Credit risk
- Client backs out from purchasing the goods
• Market risk
- Exposure to the fluctuating market price of goods
• Supplier risk
- Supplier is unknown to the bank which may cause a delay in delivery time of goods and
non-conformity to specifications
• Operational/Ownership Risk

- Client as agent gains possession of goods from the supplier without informing the bank
• Transit period Risk
- The risk associated with goods after the bank purchases them from the supplier and before
the client purchases them from the bank
• Documentation Risk
- The risk that the counter party does not provide sufficient documentation.
Risks in Salam
• Holding risk
- The risk of holding goods until the time of delivery
• Shariah non-compliance Risk
- Arises if goods are sold before receiving their physical or constructive possession
• Settlement and Delivery Risk
- Arises in the event goods are not delivered on time and do not conform to specifications
• Risk of Early Termination
- Arises in the event the client terminates the contract before delivering the goods
• Rate of Return and Price Risk
- The risk that a decrease in the commodity’s price after contract maturity will result in a
lower rate of return
Risks in Istisna
• Risk of hidden defects
- Risk of defects inherent in the manufactured products
• Shariah non-compliance Risk
- Arises as a result of not specifying the characteristics of goods, the time or place of delivery
or lack of information about the supplier
• Settlement and Credit Risk

- Arises when the customer in unable to honour deferred payments
• Price Risk
- Bank’s exposure to the risk of selling goods to a third party for a lesser price as a result of
contract cancellation
• Delivery Risk
- The risk of not being able to make a scheduled delivery of manufactured goods for a
Parallel Istisna
• Legal Risk
- Litigation costs for claims against Istisna requestor that terminates the contract
Risks in Ijarah
• Risk associated with security that sells for a lower price in the market as a result of which the
bank cannot cover its loss
• Asset Risk
- Asset is stolen, damaged
• Price Risk
- Banks exposure to changes in costs during the Ijarah’s term. The longer the term the greater
the bank’s exposure to price fluctuations
• Risk that the customer will back out from his promise to lease, the bank may have to sell the
asset at a price lower than its market price
• Legal Risk
- Litigation costs against the client who refuses to compensate the bank for losses resulting
from unfulfilled promises
Risks in Musharakah and Mudarabah
• Shariah Non-Compliance Risk
- Debt cannot be used as a substitute for equity
- One partner cannot guarantee the other partner’s principal or profit
- Risk of the funds being from a prohibited source

• Credit Risk
- Managing partner manipulates reports to show lower returns
- Silent partner opts out of partnership while still owing money
- Working partner takes a percentage of the vendor’s payment in return for awarding the
vendor a mandate.
- Prohibition of any collateral to secure the bank’s investment poses additional risk.

GLOSSARY:
COMMONLY USED
TERMINOLOGY
62
AAOIFI: The Accounting and Auditing Organization for Islamic Financial Institutions is based in
Bahrain and brings together Islamic finance scholars from around the world. AAOIFI Shariah
standards are the de facto Islamic finance standard in over 90% of the world’s jurisdictions.
Advance Against Murabaha: The amount disbursed by the financial institution for the purchase of
goods from the supplier.
Amwaal e Ribawiya: Goods which, when exchanged with one another, result in the accrual of
interest by either of the contracting parties. Six items have been classified as such by a hadith of the
Prophet Muhammad (Allah bless him and give him peace): gold, silver, wheat, barley, salt and dates.
These items may only be exchanged for each other in equal measure and at spot.
Adadiya: Countables - items which are measured as units and not by weight, length or volume, i.e.
eggs sold as units (dozen or half a dozen).
Adl: Justice, impartiality, fairness.
Adil: Trustee; an honest and trust worthy individual.
Agency Agreement: An agreement by means of which a third party whether an individual or a

financial institution is established as an agent to carry out an activity such as make an investment,
on behalf of the principal.
Ahadith: (pl.hadith) Reports of the attributes, words and deeds of the Prophet Muhammad (Allah
bless him and give him peace).
Ajr: Remuneration or compensation. In a service Ijarah, the ajr is the price paid to the employee by
the employer in exchange for services rendered.
Ajeer: Employee.
Ajeer e Aam: An employee who is not restricted to the employment of a single employer but in fact
is free to work for another person or persons as long as he fulfills his duties responsibly towards each
of them.
Ajeer e Khas: An employee for a specified term, who only serves one beneficiary.
Akl al Suht: Illegal acquisition of wealth.
Al-Ajeer al-Mushtarak: A worker who may concurrently serve or be contracted by a number of

clients, for instance a lawyer.
Al-Ajr al-Mithl: The prevalent price; the standard rate for a particular service.
Glossary of Commonly Used Terminology 63

Al-Akl bi-al-batil: Wrongful acquisition of wealth.
Al-Amin al-Amm: Trustee for property other than that granted for safe-keeping such as the lessee in
an Ijarah or the Mudarib in a Mudarabah.
Al-Amin al-Khas: Trustee for property granted for safe-keeping as in the Wadi’ah (safe-keeping)
contract.
Al-Ghunm bi-al-Ghurm: An Arab proverb according to which profit may lawfully be earned
provided risk is shared for an economic activity that ultimately contributes to the economy.
Al-Hisab al-Jari: Current account.
Al-Sanadiq: Marketing investment funds.
Amanah: Property in the safe-keeping of another (the ameen) that must be preserved and protected;
deposits maintained as trusts on a contractual basis.
Ameen: Trustee.
Amil: A worker entitled to remuneration, i.e. the Mudarib in a Mudarabah contract or a zakat
collector.
Amoor e Mubaha: Commodities that are naturally available and may be benefited from by all. For
instance, water from a river or the wood from the trees of a forest.
Amwal: (pl. maal); goods
Aqar: Real estate; immovable property, i.e. land, buildings etc.
Aqd: Contract.
Aqd al-Bai: A sale contract.
Arbaab al-Maal: Partners who contribute capital to the business, plural for Rabb al Maal.
Arbun: A non-refundable down payment received from the buyer or the Istisna requestor securing
the purchase of manufactured goods.
Ard: Land.
Ariya: A contract in which one party loans another the use of an item for an indefinite period of
time.

Arif: An expert who is consulted in matters requiring an informed and just decision.
Arkan: (lit. pillars) Fundamentals of a contract.
Asil: Assets.
Average Balance: A formula for determining the eligibility of profit a partner or Musharakah account
holder can receive on his invested amount. Essentially, it is the minimum amount that must remain
invested at all times in an account over a period of time for the account holder to be eligible to
receive profit.
Ayn: Currency or ready money, i.e. gold, silver, coins, notes or any other form of ready cash.
Bai: Contract of sale.
Bai al Dayn bi Dayn: An exchange of debt, i.e. sale of securities or debt certificates.
Bai Muajjal: A deferred sale, where one of the considerations of the contract such as its price or the
delivery of its subject matter is delayed to a future date.
Bai al Muzayadah: The sale of an asset to the highest bidder in the market.
Bai’ al Salam: A sale where the price of the subject matter is paid in full at the time of the contract’s
execution while the delivery of the subject matter is deferred to a future date.
Batil: Void, invalid; refers to a transaction, a contract governing a transaction or an element in a

contract which is invalid.
Bai al-Wafa: A sale where the seller is allowed to repurchase property through a purchase price
refund. It is a transaction prohibited by a majority of scholars.
Bai bi-Thaman ‘Ajil: (syn. bai muajjal) A deferred payment sale, where requested goods are
purchased by the bank and sold to the client for a profit. The buyer is usually permitted to complete
payments in installments.
Bai’ ‘Ajal bi al-’Ajil: (syn. bai al salam) A type of sale in which the price is paid upon signing the
contract and the delivery of goods is delayed to a future date.
Bai’atan fi Bai: Two sales in one also referred to as "safaqatan fi safaqah."
Bai al Inah: A buy-back transaction that is prohibited in Islam.
Bai al Istijrar: A contract where the supplier agrees to provide a particular product to the client on
an ongoing basis for an agreed price based on an agreed mode of payment.

Bai’ al-Kali’ bi al-Kali’: (kali. syn. debt) Sale of debt for debt, specifically prohibited by the Prophet.
In such a transaction, the creditor grants an extension in the repayment period in exchange for an
increase on the principal.
Baytul Maal: The Muslim community’s treasury.
Benchmark: A known and acknowledged standard that may already exist or alternatively be
identified by means of expert appraisal.
Benchmarking: A method by which the rent for the remaining period of an Ijarah is based upon a
known and acknowledged standard that may already exist or alternatively be identified by means of
expert appraisal.
Bond: A certificate of debt based on which the issuer agrees to pay interest if any in addition to the
principal, to the bondholder on specified dates.
B.O.T or Build, Operate and Transfer: A contract by which the government hires a contracting
company to assist it in the development of infra-structure. Usufruct for a fixed period of time is
established as the price of the contract after which ownership is transferred to the government free of
cost.
Bringing Forward Future Installments: Based on this option, in the event a client defaults on his
payment, all the installments for the entire term of the contract fall due immediately.
Buy-Back: The same as Bai inah, a prohibited type of sale in which one sells an item on credit then
buys it back for a lesser price.
Business Partnership: A joint venture or project between two or more parties entered into to make a
profit.
Capital Recovery Risk: The risk of the inability to regain capital from the security maintained by the
financial institution in case of a loss.
Catastrophic Risk: The risk arising from the possibility of the occurrence of a natural disaster causing
loss of or damage to goods.
Charity Clause: A stipulation made at the time of contract execution which establishes a certain
amount of payment to a designated charity in the event of a default.
Commodity Murabaha: A transaction where the Islamic bank purchases a commodity on spot and
sells it for a deferred payment for the purpose of managing liquidity.
Compound Interest: The accrual of additional interest on existing interest payments due on the
principal.

Commercial Interest: The excess paid in exchange for a loan taken for the establishment of a
commercial enterprise.
Commutative Contract: A contract involving an exchange.
Conditional Agency Agreement: An agency agreement where the agent is limited by certain
conditions and restrictions with respect to the execution of a required task such as the purchase of
an asset.
Constructive Liquidation: Evaluating the capital value of a business, without actually liquidating or
selling it off.
Constructive Possession: Any form of documentary evidence that proves rightful ownership of an
asset thereby sanctioning the seeking of gain from it; where the one possessing the asset is in a
position to use the item for which it is intended.
Contract: A commitment to something enjoined by the association of an acceptance with an offer.
Conventional Insurance: The conventional form of providing indemnity against loss.
Credit Risk: The possibility of a counter party failing to meet its financial obligations in accordance
to the terms agreed upon in the contract.
Credit Stage: This stage begins once the goods for a Murabaha are received by the financial
institution and the documents of offer and acceptance are signed and ends once the Murabaha
payment is recovered from the client. It is during this period that the bank has the right to accrue
profit. It is also referred to as the financing stage.
Daftur al-Tawfir: Savings account.
Dayn: A debt created by a contractual obligation or credit transaction.
Dhaman: A contract of guarantee whereby a guarantor underwrites any claim or obligation to be

fulfilled by the owner of the asset.
Deal Ticket: A form of documentation evidencing the acceptance of funds by one bank from another
based on a Musharakah contract.
Default: A contracting party’s failure to make a due payment.
Dhimmah: Liability.
Dhulm: Refers to all forms of injustice, exploitation or oppression through which a person deprives
others of their rights or does not fulfill obligations towards them.

Diminishing Musharakah: A temporary partnership where an asset or property is jointly purchased

by two partners and one partner eventually acquires ownership of it through a series of property
share purchases.
Dinar: A gold coin used by early Muslims. Its standard mass was app. 4.25 grams.
Displaced Commercial Risk: Islamic financial institutions manage the funds of investment account
holders on a profit-and-loss-sharing basis. However, in order to maintain competitiveness with
conventional banks which offer fixed returns, IFIs typically surrender part (or all) of their profit share
in order to allow their depositors to receive their expected profit allocation. This effectively means
that the risk attached to depositors’ funds is partially or wholly transferred to the IFI’s capital, which
increases the overall risk for IFIs and is referred to as DCR.
Earnest Money: A sum received from the client as security that serves as compensation in the event
the lessee backs out from entering into or continuing an Ijarah. The lessor makes up for the actual
loss from it and returns the remainder to the client.
Equity: The ownership share in a business.
Equity Investment Risk: The risk arising from entering into a partnership in order to finance a
particular or general business activity, where the manager of finance also shares the business risk.
Equity Market: The equity market is the place where company shares are traded thereby providing
viable investment opportunities to individuals, other companies and financial institutions seeking to
avail them.
Faqih: Muslim jurist.
Faqir: A needy person.
Fasid: Voidable, usually said of a contract or an element within a contract.
Faskh: Cancellation of a contract, usually based on one of the contracting parties exercising an
option, i.e. the option of return in case of a defective asset or the option of refusal to purchase an
asset.
Fatwa: An authoritative legal judgment based on the Shariah.
FI Pool: A Musharakah based financial investment pool created by the Islamic financial institution to
manage liquidity.
Financing Stage: This stage begins once the goods are received by the financial institution and the
documents of offer and acceptance are signed and ends once the Murabaha payment is recovered
from the client. It is during this period that the bank has the right to accrue profit.

Fiqh: Islamic jurisprudence.
Fiqh al Muamalat: Islamic jurisprudence governing financial transactions.
Foreign Currency Commodity Murabaha: A transaction commonly used for investing excess funds
which is available for maturities ranging from overnight to a period of one year. The commodity used
in the transaction exists with a foreign asset exchange company.
Fuduli Transaction: A transaction with another's property without Shariah consent. For instance,
selling property before contracting an agency agreement with its owner is a “fuduli” transaction.
Fungible Goods: Goods that are similar to one another and are sold as units, any difference between
them is considered negligible.
Gharar: Contractual uncertainty that may lead to major dispute between contracting parties which is
otherwise preventable or avoidable.
Ghasb: The misappropriation of property.
Global Agency Agreement: An agreement where the agent may purchase the required asset from any
source of his choice. Such an agreement also lists a number of assets which the agent may procure
on the bank’s behalf without having to execute a new agency agreement each time.
Guarantee: A risk mitigating technique that serves as a form of security in contracts and is provided
by a third party. For instance, a guarantee for the supply of specific goods at a specific time or a
guarantee for a timely payment.
Hadith: A report of the attributes, words and deeds of the Prophet Muhammad (Allah bless him and
give him peace).
Halal: Permissible in the Shariah
Haamish Jiddiah: The Islamic financial term for a sum of earnest money received from the client as
security that serves as compensation in the event the lessee backs out from entering into or
continuing an Ijarah. The lessor makes up for the actual loss from it and returns the remainder to the
client.
Hand-to-Hand Sale (Mu’ata): A sale where the seller hands the asset over to the buyer in exchange
for a price without any verbal expression of offer or acceptance.
Haq: Right.
Haq Dayn: Debt rights.

Haq Mali: Rights over financial assets.
Haq Tamalluk: Ownership rights.
Haram: Prohibited in the Shariah.
Hawala: A contract by which a debtor transfers his debt to a third party.
Hawl: The amount of time that must elapse before a Muslim possessing funds equaling or exceeding
the exemption limit/nisab, is required to pay zakat. Typically, one Islamic year/lunar year.
Hiba: Gift.
Holding Risk: The risk that accompanies the possession of assets by the financial institution before
they are delivered to the buyer.
Homogeneous Commodities: Commodities that are similar to one another and are sold as units. The
difference between them is negligible.
Huquq: (Pl. haq) Rights.
Hybrid Sukuk: Certificates of ownership representing trust assets for more contracts than one.
ICD: Islamic Corporation for the Development of the Private Sector.
IDB: Islamic Development Bank.
IFI: Islamic financial institution; i.e. bank or financial organization operating commercially within
the limits prescribed by Shariah.
IFSB: International Financial Standards Board.
Ihtikar: Hoarding
Ijab: Offer, in a contract.
Ijarah: A form of lease seeking to provide the benefits of an asset or a service to the lessee in return
for a payment of an agreed upon price or rent.
Ijarah tul Amaal: A contract of lease providing services for an agreed upon rental.
Ijarah tul Ashkhaas: (syn. ijarah tul amaal) A contract of lease providing services for an agreed upon
rental.

Ijarah tul Manaafay: A contract of lease executed for the transfer of the benefits of an asset in
exchange for an agreed upon price.
Ijarah Mawsoofah fi Dhimma: A lease agreed upon and based on a deposit for the future use or
delivery of an asset.
Ijarah Muntahiya bi Tamlik: An Ijarah based on the lessor’s undertaking to transfer the ownership of
the leased property to the lessee at the end of the lease or by stages during the term of the contract.
Ijarah Sukuk: Certificates representing the ownership of leased assets, the ownership of the usufruct
of leased assets or the ownership of the rights to receive benefits from services.
Ijarah wa Iqtina: An Ijarah conducted solely for the purpose of transferring the ownership of the
leased asset to the lessee at the end of the lease period.
Ijma’: Juristic consensus on a specific issue. It is recognized as one of the four sources of Shariah.
Ijtihad: Juristic reasoning based on the Quran and the Sunnah.
Illah: The attribute of an event requiring a specific ruling in all cases possessing that attribute;
analogies are drawn based on it to determine the permissibility or prohibition of an act or
transaction.
Inaan: (A type of Shrikah) A form of partnership in which each partner contributes capital and has a
right to work for the business.
Infisakh: Contract cancellation without the will of the contracting parties, i.e. as a result of an asset’s
destruction or the death of a party to the contract.
Informational Asymmetry: A situation where important relevant information is known by some

parties, but not by all.
In-kind: Where instead of cash, payment or capital contribution is made in the form of tangible
assets, goods or services.
Interest: Any addition or increment involved in an exchange between contracting parties.
Investment Stage: This is the stage that begins after the execution of the agency agreement. It is the
time period during which the bank has disbursed the money for the purchase of the asset from the
supplier but has not yet acquired possession of it in order to sell it.
Ishara: A gesture made by a person’s head or hand taking the place of speech in expressing the will
of two contracting parties.

Israf: Immoderateness and wastefulness.
Istighlal: Investment.
Istihlak: Consumption.
Istihsan: Judicial preference for one legal analogy over another in view of general public welfare.
Istijrar: A contract where the supplier agrees to provide a client a particular commodity on an
ongoing basis for an agreed price based on an agreed mode of payment.
Istisna: A transaction used for the purpose of acquiring an asset manufactured on order. It may be
executed directly with the supplier or any other party that undertakes to have the asset
manufactured.
Istisna Requestor: The party placing the manufacturing order.
Istisna Sukuk: Certificates representing proportionate ownership of manufactured goods.
Joa’ala: A contract involving a reward for a specific service or achievement.
Jadwala: Rescheduling.
Jihalah: Ignorance; inconclusiveness in a contract leading to gharar.
Kafalah: A third party taking responsibility for another’s repayment of debt; a pledge given to the
creditor that a debtor will repay his debt.
Kafil: The party assuming responsibility for repayment of another’s debt in a kafalah contract.
Kali bil Kali: The exchange of debt for debt.
Kharaj: The share of the produce from agricultural lands collected by Muslim rulers and added to
the Bayt al-Maal.
Khayaar: Option or power to annul or cancel a contract.
Khayaar e Aib: The option of return in case of a defective asset.
Khayar e Majlis: The option to annul a contract possessed by both contracting parties.
Khayaar e Rooyat: The option of refusal based on which the buyer may decline from accepting the
goods of a sale as a result of non-conformity to specifications.

Khayaar e Shart: An option in a sale’s contract established at the time of signing the agreement
giving one of the two parties to the contract a right to cancel the sale within a stipulated time.
Khayaar e Taaeen: The purchaser’s option to return an asset to the seller in case it does not meet
specifications as established at the time of contract execution.
Khilabah: Fraud in word or deed by a party to the contract to coerce another into entering into a
contract.
Khiyanah: Deception by withholding information, or breach of an agreement.
KYC: (Abb.) Know-Your-Client; the due diligence checks carried out on customers to determine their
credit worthiness.
Legal Risk: The risk of having to resort to litigation for redemption of claims arising from a contract.
LIBOR: London Inter-Bank Offered Rate.
Lien: A charge, claim, hypothecation or mortgage, pledging an asset to a creditor.
Liquidity Management: The management of an excess or shortage of funds by financial institutions

through inter-bank treasury transactions to meet day to day business needs and liquidity reserve
requirements.
Local Currency Commodity Murabaha: In the absence of an organized asset exchange market, the
LCC Murabaha is conducted for the management of funds at financial institutions with the help of
local commodities exempt from value added tax.
Luqta: An item misplaced by its owner and found by someone else.
Madhab: (pl. madhahib) A school of Islamic jurisprudence characterized by differences in the way
Shariah sources are understood, forming the basis for differences in Shariah rulings derived from
them. The four Sunni schools named after their founders are Hanafi, Maliki, Shafiì and Hanbali.
Maisir: 1) The act of gambling or playing games of chance with the intention of making an easy
profit; 2) the element of speculation in a contract; 3) chance or uncertainty with respect to an
outcome.
Major Maintenance: The fulfillment of all the requirements that ensure that the leased asset provides
intended use.
Maal: Wealth; anything of value that may be possessed.

Maal-e-Mutaqawam: Items that are lawful to use or consume by Shariah; or wealth considered
commercially valuable by Shariah.
Manfa’ah: Usufruct or benefit derived from an asset.
Maqasid al-Shariah: The establishment of goals and objectives by Muslim jurists in a way that assists
the investigation of new cases and the organization of prior rulings.
Market Risk: The current and future volatility of the market value of specific assets to be purchased
and delivered over a specific period of time such as the commodity price of a Salam asset, the
market value of a Sukuk, the market value of a Murabaha asset and the fluctuating rates of foreign
exchange.
Minimum Balance: A formula for determining the eligibility of profit a partner or Musharakah
account holder can receive on his invested amount. Essentially, it is the minimum amount that must
remain invested at all times in an account over a period of time, for the account holder to be eligible
to receive profit.
Moral Hazard: Risk of a party acting either in bad faith, or underperforming due to negligence and
indifference, brought on by insulation from risk.
Mu’amalah: A financial transaction.
Mubah: Object that is lawful; an item permissible to use or trade.
Mudarabah: A Mudarabah is a business partnership between two or more parties, where, typically,
one of the parties supplies the capital for the business, and the other provides the investment
management expertise. Also known as Muqaradah or Qirad.
Mudarib: Partner responsible for management in a Mudarabah, also defined as an investment

manager.
Mudarabah Sukuk: Certificates representing the proportionate ownership of capital for specific
projects undertaken by an entrepreneur.
Mufti: A highly qualified jurist who issues fatawa or legal verdicts.
Mugharasa: An agricultural contract similar to muzaraàh in which a land owner agrees to grant the
farmer a share of the harvest from the fruit orchard he tends.
Muwaada/ Mua’hida: A bilateral promise.
Mujtahid: A highly qualified fiqh specialist who engages in independent juristic reasoning.

Mukhabarah: An agreement between a landowner and a farmer, similar to a muzara’ah the only
difference being that in a muzaraàh the seeds are provided by the landowner whereas in a
mukhabarah they are supplied by the farmer.
Muqassa: Setting off two debts at an agreed exchange rate.
Murabaha: A contract in which the cost of acquiring the asset and the profit to be earned from it are
disclosed to the client or the buyer.
Murabaha Facility Agreement: An agreement including the approval of the credit facility extended
to the client, the terms and the conditions of the contract, the specification of the Murabaha asset
and the client’s promise to purchase.
Musawamah: A general sale in which the price of the commodity to be traded is bargained between
the buyer and the seller and where no reference is made to the cost of acquisition of the sale asset or
the profit to be earned from it.
Musaqah/Musaqat: A partnership whereby the owner of an orchard agrees to share the produce with
a farmer as a recompense for the farmer tending the land.
Musharakah: A business partnership set up to make profit, where all partners contribute capital and
effort to help the business run.
Musharik: A partner in a Musharakah.
Mutual Insurance: A form of insurance where a group of people exposed to a similar risk, by mutual
consent make voluntary contributions to a pool of funds to share that risk and provide one another
with indemnity against loss.
Muwakkil: The principal in an agency agreement.
Muzara’ah: Share-cropping; an agreement where one party agrees to allow a portion of his land to
be farmed by another in exchange for a part of its produce.
Najash: Deceiving a potential buyer during pre-sale dialogue, through insincere bidding by a third
party (a party expressing insincere desire to purchase the commodity at a higher price) or false
claims on the seller’s part.
Negligence: Loss resulting from the violation of the conditions of a contract.
Nisab: The exemption limit for paying zakat. A Muslim possessing wealth below the nisab is exempt
from zakat whereas a Muslim with wealth at or exceeding the nisab is obligated to pay zakat.
Numeraire: A basic standard by which comparative values are measured, or a unit of account.

Offer and Acceptance: The actual execution of a sale, where one of the contracting parties makes
an offer to sell or purchase an asset and the other accepts it.
Operational Risk: The risk of direct or indirect loss resulting from inadequate or failed internal
processes, people and systems or from external events as well as non-compliance to Shariah
regulations or a neglect of fiduciary responsibilities.
Parallel Istisna: Another contract of Istisna executed alongside the original Istisna. The manufacturer
in the original contract serves as the Istisna requestor in the parallel contract and profits from a
difference in price.
Periodic Maintenance: Regular maintenance of the leased asset.
Permanent Musharakah: Also referred to as an ongoing Musharakah, a partnership where there is no

intention of terminating or concluding the business venture at any point.
Physical Possession: The actual or corporal possession of an asset and the ability to benefit from it.
Pledge: A form of security that is taken from the client and maintained by the financial institution. It
may be in the form of an asset or cash.
PLS: Profit and Loss Sharing; used to describe interest-free Islamic finance schemes, typically
represented by Musharakah and Mudarabah
Possession: The ownership of all the risks and rewards associated with an asset.
Premium: The amount of contribution made by the insured to the pool of funds established for the
purpose of providing indemnity against loss.
Price Risk: The risk arising from the fluctuating price of goods in the market, thereby affecting the
value of the goods of the contract.
Private Equity: Shares in a business that are not for sale to the general public but are sold exclusively
through invitation to certain parties.
Project Finance: The financing of large infrastructure and industrial projects based on a
comprehensive financial structure for operation.
Promise: An undertaking by the client to enter into a contract with the financial institution for the
sale or lease of an asset in the future.
Provisional Profit: The profit earned by the investor for the period of time his funds remained
invested.

Pure Risk: The risk that involves the possibility of loss or no loss. For instance damage to property
due to a fire that may or may not occur.
Qabda: (lit. to seize) Take possession of the exchange commodity in an exchange transaction.
Qard: Loan.
Qard e Hasana: A goodwill loan against which interest is not charged; where only the principal
amount is to be returned in the future.
Qimar: An agreement where the acquisition of an asset is contingent upon the occurrence of an
uncertain event in the future.
Qirad: Alternative name for Mudarabah or Muqaradah.
Qiyas: Drawing a comparison; deriving law through analogy from an existing law if the basis for
both is the same; also one of the Shariah sources.
Qubul: Acceptance, in a contract.
Ra’s al maal: Capital; the money or capital which an investor (Rabb al Maal) invests in a profit-
seeking venture.
Rabb al Maal: The investor or the owner of capital in a Mudarabah contract.
Rahn: Collateral; a pledge or the transaction which governs such a pledge.
Rate of Return Risk: The risk that a financial institution is exposed to as a result of an undetermined
or variable amount of return on an investment.
Receivable: An asset or cash that a business is due to receive as a result of a prior transaction.
Restricted Mudarabah: A Mudarabah in which the Mudarib has to observe certain restrictions
regarding how the business may be run. Typically, these restrictions may relate to sector, activity,
and/or region in which the business may be operated (various other restrictions also may be
included).
Re-Takaful: The re-Takaful is a new Takaful arrangement consistent with Takaful principles and
guidelines provided by the Shariah board. It is enacted in the event that the funds in the original
Takaful are not sufficient to meet the needs of its members.
Riba: Any amount that is charged in excess which is not in exchange for a due consideration.
Conventionally it is referred to as interest and is prohibited in Islam.

Riba al Buyu: The Riba of exchange surplus. Any barter transaction where like commodities are
exchanged in unequal measure, or the delivery of one commodity is postponed, is characteristic of
Riba al Buyu.
Riba al Fadl: The same as Riba al Buyu.
Riba an Nassiya: The predetermined excess repayable on the principal extended as a loan.
Riba al Quran: The same as Riba an Nassiya.
Ribawi: Goods subject to Shariah rulings with respect to Riba in the event of their sale.
Risk: An exposure to the likelihood of loss, where this loss takes many forms depending on the kind
of risk involved. It is the possibility that the outcome of an action or event could bring an adverse
impact resulting in a direct loss of earning and capital or the imposition of constraints in the bank’s
abilities to meet its business objectives.
Risk Management: The process of evaluating and responding to the exposure facing an organization
or an individual. It is a structured and disciplined approach employing people, processes, and
technology for managing uncertainties faced by an organization.
Rishwa: Bribery.
Roll-over: A roll-over is the provision of an extension in return for an increase in the original payable
amount.
Rukn: (lit. pillar) Fundamental of a contract.
Sa’: A dry measure in use in Madinah during the time of the Prophet used to weigh dates, barley and
other similar items.
Sadaqah: Voluntary charitable donations.
Sahih: (lit. sound, correct) In reference to: 1) A valid contract, 2) A highly authenticated hadith.
Sak: (pl. Sukuk) Certificate of equal value representing an undivided share in the ownership of a
tangible asset, usufruct or service.
Salaf: A loan that draws no profit for the creditor. Salaf is also referred to as Salam where the price of
the subject matter is paid in full at the time of the contract’s execution while the delivery of the
subject matter is deferred to a future date.
Salam: A sale where the price of the subject matter is paid in full at the time of the contract’s
execution while the delivery of the subject matter is deferred to a future date.

Sale Contract: The commitment to trade a commodity in a specific manner for a consideration in
cash or kind, evidenced by the exchange of an offer and acceptance.
Salam Sukuk: Certificates representing financial claims arising from the purchase of commodities to
be delivered in the future based on an advance payment of price.
Sarf: Currency exchange.
Securitization: The process of issuing certificates of ownership against an asset, an investment good
or a business.
Share: A form of equity ownership representing claims on earnings and assets.
Shart: (pl. shurut) A necessary condition or stipulation, that must exist to ensure the validity of a
transaction.
Shart e Jazai: The Shart e Jazai is a penalty established at the time of the execution of the Istisna
contract which allows for a reduction in the price of the manufactured goods in the event of a delay
in their delivery.
Shariah: Islamic law.
Shariah Advisory Board: A panel of Shariah scholars appointed by Islamic financial institutions to
supervise all transactions and ensure their Shariah compliance. Its role also includes conducting
regular and annual audits.
Shariah Non-Compliance Risk: The risk arising from non-compliance to the standards of Islamic law.
Sharik: Partner.
Sharikah: The same as Shirkah
Shirkah: (lit. sharing) Refers to different kinds of business partnerships based on sharing.
Shirkah tul Aa’maal: A partnership based on the pooled provision of services.
Shirkah tul Wujooh: A ‘partnership of goodwill’ where the subject matter is bought on credit from
the market on the basis of a relationship of goodwill with the supplier, with the aim of reselling at a
profit to be shared.
Shirkah tul Aqd: A ‘business partnership’ established through a deliberate contract.

Shirkah tul Amwaal: The commonest type of Shirkah tul Aqd which refers to a partnership between
two or more parties for the purpose of earning profit by means of investment in a joint business
venture. Also known as Shirkah tul ‘Inaan.
Shirkah tul Inaan: It is the commonest type of Shirkah tul Aqd and refers to a partnership between
two or more parties for the purpose of earning profit by means of investment in a joint business
venture.
Shirkah tul Milk: Primarily a ‘partnership of joint ownership’ which may come about deliberately or
involuntarily.
Sigha: Formulation of the contract, often referred to as ‘offer and acceptance.’
Silent Partner: A partner in the business who only contributes capital but takes no part in
management of the business; also referred to as the sleeping partner.
Simple Interest: The excess or increment that is charged over and above the initial investment.
Sleeping Partner: A partner in the business who only contributes capital but takes no part in
management of the business; also called silent partner.
Sole Proprietorship: A business fully owned and managed by one person.
Specific Agency Agreement: An agreement based on which the agent is under restriction to
purchase a specified asset from a specified supplier only.
Speculative Risk: The risk representing potential gain or profit, i.e. the risk involved in a new
business venture.
SPV: (Abb. Special Purpose Vehicle) An independent entity created based on the Mudarabah
contract for the purpose of generating funds by acquiring assets from a company and issuing
certificates of proportionate ownership against them.
Specific Commodities: Commodities possessing specific attributes that make them different from
one other. One may not be replaced by the other, for instance livestock, precious stones.
Standard Ijarah: A lease contract executed for the provision of usufruct for a fixed term at the end of
which the ownership of the leased asset is not transferred to the lessee.
Stock Company: A company in which the capital is partitioned into equal units of tradable shares
and each shareholder’s liability is limited to his share in the capital; it also represents a form of
partnership.
Sublease: The lease of an already leased asset to a third party with the primary lessor’s consent.

Sukuk: Certificates of equal value representing undivided shares in ownership of tangible assets,
usufruct and services.
Sukuk al Ijarah: Certificates representing the ownership of leased assets, the ownership of the
usufruct of leased assets or the ownership of the rights to receive benefits from services.
Sukuk al Mudarabah: Certificates representing the proportionate ownership of capital for specific
projects undertaken by an entrepreneur.
Sukuk al Murabaha: Certificates representing the investor’s shares in receivables from the purchaser
of assets based on a deferred sale.
Sukuk al Musharakah: Certificates representing proportionate ownership of a Musharakah asset, be it

a partnership for new projects or a partnership for the expansion of existing projects.
Sukuk al Salam: Certificates representing financial claims arising from the purchase of commodities
to be delivered in the future based on an advance payment of price.
Sunna: The personal example, comprising words and deeds of the Prophet Muhammad (Allah bless
him and give him peace).
Ta’awun: Co-operation.
Tabburro: Gift or contribution.
Tadlis al aib: Refers to the activity of a seller concealing the defects of goods.
Takaful: A Shariah-compliant system of insurance based on the principle of mutual co-operation.

The company’s role is limited to managing operations and investing contributions.
Takaful Operator: The manager of Takaful funds.
Tawarruq: A mode of financing, similar to a Murabaha transaction, where the commodity sold is not
required by the client but is bought on a deferred payment basis and sold to a third party for a lesser
price, thereby becoming a means of liquidity generation.
Thaman: Price.
Thaman al bai: Sale price.
Tijarah: Trade.
Time-Sharing Leasing Contract: The lease of a single asset to multiple lessees by means of different
leasing contracts for different time periods, with none of them overlapping with one another.

Trade Finance: The financing of international trade transactions, which involves satisfying the needs
of importers and/or exporters.
Transit Period Risk: The risk posed to the bank for the time period that ensues after assuming
possession of Murabaha goods from the supplier and before selling them to the client.
Treasury Operations Department: The section of the financial institution that deals with the
maintenance of funds and capital reserves and their movement in and out of the bank.
Two-Tier Business Model: Where one set of capital investments enables a stream of follow-on
investments in multiple Shariah-compliant ventures.
Ujrah: Financial payment for the utilization of services.
Ulema: Muslim scholars.
Ummah: The Muslim community.
Unconditional Agency Agreement: An agency agreement where the principal does not stipulate any
conditions or restrictions upon the agent’s performance of duties. The agent is allowed to exercise
his own discretion with reference to the assigned task, taking into consideration the market norm.
Unrestricted Mudarabah: A Mudarabah in which the Mudarib has a free hand regarding where and
how to invest the capital of the business.
Uqud al Mu’wadat: Exchange contracts.
Uqud al Ishtirak: Partnership contracts.
Uqud al Tabbaruat: Charitable contracts.
Urf: Market norm.
Ushr: Islamic tax on agricultural produce.
Usufruct: The benefit received from an asset in a contract of lease.
Usul al Fiqh: Sources of law.
Usury: An exorbitant amount of interest or any rate of interest or the excess paid in exchange for a
loan granted for personal use.
Voluntary Contract: A contract based on the mutual co-operation of contracting parties for which
remuneration is not granted or received.

Wa’da: Promise; an undertaking regarding future actions.
Wadià: Safe-keeping deposit.
Wadia yad Dhaman: Goods or deposits granted for safekeeping. As Wadia is a trust, the depository
becomes the guarantor for repayment on demand, of all the deposits or any part that remains
outstanding in the accounts of depositors. The depositors are not entitled to any of the profits but the
depository may grant them a portion of the returns at its own discretion.
Wakalah: An agency contract which usually includes in its terms a fee for the agent.
Wakalah tul Istismaar: An investment management contract
Wakalah Muqayyada: The same as the conditional agency agreement.
Wakalah Mutluqqa: The same as the un-conditional agency agreement.
Wakalah tul Ujrah: Agency executed for a fee.
Wakeel: Agent.
Wakeel bil Bai: The agent assigned to sell.
Wakeel bil Khasooma: The agent assigned to deal with common disputes.
Wakeel bil Qabd: The agent assigned to take possession of debt.
Wakeel bi Shara: The agent assigned to purchase.
Wakeel bi Taqazidain: The agent assigned to retrieve debt.
Waqf: A legal entity that has the potential to own, purchase and sell in addition to grant and receive
gifts.
Wasiya: Will, bequest.
Weightages: Ratios calculated for the appropriate allocation of profit and assigned to investment
categories at financial institutions. They are subject to change with changes in market trend; the
longer the term of deposit, the greater the weightage assigned to it.
Working Partner: A partner who is responsible for running the business.
Wujuh: (Lit.face) Interpreted in financial transactions as goodwill or credit for partnership.

Zakat: (see also Zakat al Maal) A tax imposed by Islamic law on all persons possessing wealth at or
above an exemption limit (nisab). Its objective is to collect a portion of wealth of the affluent
members of society and distribute it amongst the underprivileged. It may be collected by the state or
distributed by the individual himself.
Zakat al Fitr: A small obligatory tax imposed on every Muslim who has the means for himself and
his dependants. It is paid once annually at the end of Ramadan before Eid al Fitr.
Zakat al Maal: The Muslims wealth tax; a Muslim must pay 2.5% of his yearly savings at or above
the nisab, to the less fortunate members of the community. Zakat is obligatory for all Muslims who
have saved the equivalent of 85g of gold at the time when the annual zakat payment is due.
Zakat al Maadan: Zakat on minerals.
Zakat al Hubub: Zakat on grain / corn.
Zakat al Tijarah: Zakat on profits from trade.
Zakat al Rikaz: Zakat on treasure/precious stones.

CONTACT ETHICA
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PO Box 127150, Dubai, UAE
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CIFE™ STUDY NOTES

ABOUT ETHICA INSTITUTE OF ISLAMIC

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About Ethica Institute of Islamic Finance 3

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About Ethica Institute of Islamic Finance 4

ABOUT ETHICA’S CERTIFIED ISLAMIC

The program fee is $1,495 (discounted for

• 4 months access to self study videos

• CIFE™ Certificate couriered to your

• Ethica's 1-on-1 Career Counseling

• Ethica's Recruiter's Database

One module consists of an approximately 20 minute training video comprising a variety of

About the Certified Islamic Finance Executive™ (CIFE™) 6

CIFE02 Understanding You've heard of joint-stock companies. Now learn Week 1

CIFE03 Understanding We discuss the management of the Musharakah Week 2

CIFE04 Understanding We complete our discussion on general aspects of Week 2

About the Certified Islamic Finance Executive™ (CIFE™) 7

CIFE06 Understanding Mudarabah How is an investment partnership different from an Week 3

CIFE07 Understanding Mudarabah We discuss the Mudarabah's management and Week 4

CIFE11 Understanding Murabaha II Wrap up the 7 steps to executing a Murabaha: we Week 6

About the Certified Islamic Finance Executive™ (CIFE™) 8

About the Certified Islamic Finance Executive™ (CIFE™) 9

About the Certified Islamic Finance Executive™ (CIFE™) 10

CIFE™ STUDY NOTES

CIFE™ Study Notes 11

Conventional banking transactions are interest

Islamic bank transactions are asset or service backed.

Nigerian President Obasanjo – Example

• Or purchased commodities and sold them at a premium using a Murabaha.

• Or structured a project financing using an Ijarah Sukuk.

CIFE™ Study Notes 12

Nick the Homebuyer – Example

Based on a Diminishing Musharakah.

Faisal the Student – Example

How would an Islamic bank fulfill Faisal’s need?

Islamic Finance Essentials

CIFE™ Study Notes 13

Some important Islamic finance transactions:

• Equity based - Mudarabah, Musharakah, and Sukuk

• Trade based - Murabaha, Salam, and Istisna

• Lease based - Ijarahs

Islamic banking transactions must:

CIFE™ Study Notes 14

CIFE02, 03, 04:

CIFE™ Study Notes 15

• Shirkah tul Aqd

• Shirkah tul Milk

Differences between Shirkah tul Aqd and Shirkah tul Milk

2. Shirkah tul Milk is a partnership of joint ownership as opposed to a commercial venture

Types of Shirkah tul Aqd:

CIFE™ Study Notes 16

All Shariah–compliant items of material value may be used as capital in a Musharakah.

Debt may not constitute Musharakah capital.

CIFE™ Study Notes 17

Musharakah Profit and Loss

• Profit may not be set as a percentage of capital.

Profit is calculated by subtracting costs and expenses from revenue.

Loss can only be shared by capital contribution ratios.

CIFE™ Study Notes 18